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Generally, when I post about an InterETF trade setup, it is in the small-cap arena or, sometimes, the financial sector. The chaos in the Middle East has oil prices moving and the volatility around this black gold is heating up, which translates into opportunities within the ETF and leveraged ETF space. The direction of oil could go either way from the $100 barrel level. So rather than bet on a direction or even the inherent movement of a direction with a cushion built in, I would prefer to approach a trade setup that offers some cushion in price, but isn't wagering on a specific direction. The setup I am looking at is somewhat akin to an iron condor, but I want the potential for upside if volatility increases and oil prices rock back and forth.

My first trade setup is inherently bearish, meaning it will make money if the price of crude stays flat or moves lower. Since this is a March setup, I am going to build in a small 2.5% cushion to the upside, so that there is the potential for this pair leg to make a profit -- even if oil rises higher into March expiration. I have gone long the March 45 puts on the ProShares UltraShort Crude Oil ETF ( SCO) while shorting the March 41 calls on the U.S. Oil ETF ( USO). This pair carries with it one long SCO put by 2.5 short USO call, or 2 by 5 for those not wanting to do the math. The trade brought a net credit of $0.27. Based on current prices, SCO should reach $45 before USO reaches $41; however, since we are dealing with leverage and contango on the underlying ETFs, I will keep track of this each day to be aware of my risk.

Using the same setup but with options that will expire in April, I have implemented a second trade, which is also inherently bearish, but to a smaller degree. This same trade brought a net credit of $0.47, but I am only doing half as many of this pair as compared to the March pair because the tilt for oil is still bullish.

The third and final part of the trade is inherently bullish. It consists of going long the April 44 puts on the ProShares Ultra Crude Oil ( UCO) while shorting 2.5 USO March 37 puts for a net credit of $0.22. This trade carries the same ratio as the previous USO-SCO pair. This trade will be equal in size to the total volume of the March and April USO-SCO pair. By equaling the inherently bullish and inherently bearish pairs, this trade creates a setup similar to an iron condor.

The reasoning behind my thinking is that I am short-term neutral to bullish on oil prices; therefore, I want more of my inherently bearish trades to expire sooner. If oil prices are flat or higher come March expiration, then I will be able to roll my March InterETF oil pairing into April for a larger net credit or roll the positions further out of the money. If oil prices remain flat or volatility comes out of the commodity, then there is a strong likelihood that all the pairs could be closed for less than the original net credit received. I like the flexibility and neutrality of this setup in the current environment.
At the time of publication, Collins was long SCO puts and UCO puts and short USO calls and USO puts.

Timothy Collins has worked as a financial adviser since 1999, focusing on portfolio customization, with a concentration on correlation arbitrage and risk-managed growth. He started Collins Capital Advisors in 2007, which has evolved into TangleTrade Management, LLC. TangleTrade is an RIA firm dedicated to formulating customized risk-managed investment strategies for individuals and small businesses. TangleTrade Management now manages the TangleTrade Fund, a correlation arbitrage hedge fund utilizing the trademarked InterETF strategy.

Prior to joining his first firm, American Express Financial Advisors, in 1999, Collins worked as a staff accountant for United Information Systems in Bethesda, Md. He has also worked as a financial analyst for Securities Pricing and Research in Annapolis, Md. Collins is a graduate of McDaniel College (formerly Western Maryland College), with degrees in business administration, economics and sociology and is a winner of the Bates Prize.

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