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Crude Oil Volatility: How to Play It

Crude oil futures have been volatile recently. Here are options trades aimed at profiting from that volatility.
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) -- After another selloff Monday, June crude oil futures are bouncing back this Tuesday morning and were trading up 74 cents at $83.87 per barrel.

Crude oil futures have been quite volatile following the news on Friday that

the Securities and Exchange Commission was filing fraud charges


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. The market has also been hit by some renewed economic jitters and worries over sovereign debt issues.

Fundamentally, crude oil does not deserve to be trading in the mid-$80-per-barrel range. The market remains extremely well supplied. I think it is more the work of large players and speculators driving this market higher. In addition, the constant threat of an Israeli strike against Iran will keep a floor under crude oil prices.

Volatility is our friend, because it helps us collect premiums.

Here are two ways to potentially take advantage of the volatility we are seeing in June crude futures:

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Even through the turmoil of the last two sessions, June crude futures have tested the top end of their prior trading range and thus far are holding out. This is a technically significant development.

Right or wrong, this market wants to hold its gains and or proceed higher. Because of this, I recommend being a put seller. Look to sell the June 75 puts for $500 or better.

With commissions and fees not exceeding $50.00 per contract, this will leave the investor with a net premium of $450.00. These options expire in 27 days, on May 17. This would make the break-even point at expiration $74.55 on the June futures contract.

This is a margin position, and an investor may be forced to close the position at any time before expiration due to adverse market movements or a margin call. Remember that option selling involves unlimited risk and is not suitable for all investors. An investor can lose more than his or her original investment.

This position can potentially profit if June crude futures stay above $75 per barrel at expiration. The maximum profit that can be achieved is the premium collected ($500) minus commissions and fees not exceeding $50. Thus, a maximum profit of $450 can potentially be achieved. This position can also potentially profit by a decrease in implied volatility. The position can be closed at a profit or loss at any time before expiration.

Investors looking for a trade with strictly defined risk parameters can purchase call options. Because the June options have only 27 days left, I recommend buying calls that are close to the money or to the current June futures price with a decent delta.

The June $8650 call option can be purchased for approximately $1500 plus commissions and fees not exceeding $50 per contract, for a total cost of around $1550 per position. The maximum risk on this trade is the dollar amount spent on the purchase (in this case $1550).

The position breaks even if June oil futures are at $88 at expiration. Above $88, the option is in the profit zone. Below $88, the investor starts to lose money on the position. If June oil futures are below the strike price of $8650 at expiration, the investor will lose the entire premium paid. This position can be profitable if June futures prices start approaching the strike price of $8650. It can also profit from an increase in volatility.

-- Written by Matt Zeman in Chicago


Risk disclosure: Past performance is not indicative of future results. The risk of loss in trading futures and options is substantial and such investing is not suitable for all investors. An investor could lose more than the initial investment.

Matt Zeman is a principal with Lasalle Futures Group and chief market strategist for Time Means Money.Com.