I have noticed that a growing number of people outside the world of Commodity Trading are gaining a familiarity with the terms used to describe the prices of Commodities Futures. I hear the term Contango all over the media now and I thought it was reserved just for us trading geeks. Contango refers to a condition where the futures are pricing that particular commodity or instrument at a higher price as time goes on. In many commodities, there are futures for any number of months or years going forward. The subsequent futures reflect the expectation for that commodity going forward.

The commodity responsible for bringing the attention to our world is Oil. The futures 1 to 3 months out are trading at a radically higher price than the current price of oil. It was close to 13 % higher at the time of this writing. That is dramatic and it is causing many speculators to scramble to secure barges or storage facilities to hoard oil and park it offshore until the price rebounds as they are anticipating. They reason that if the futures are accurately predicting the distant price of oil, the storage costs will be just a drop in the barrel of the profit they will garnish. Many players who don't know a tanker from a dinghy are looking to get in the game.

What does that mean for the trader who does not want to install a storage unit in their yard or secure a tanker and park it offshore? The spreads we are seeing are unprecedented. We can look at this a couple of different ways. I believe something is out of whack with respect to oil prices. Either the future prices will stay at the current levels or they will pop back to the levels the futures contracts are indicating in the next couple of months. It is my opinion that last year when oil was approaching $150.00 a barrel it was completely overdone to the upside and we are currently seeing the same thing on the downside. I realize demand is vanishing but they are still fundamental needs for petroleum which must be met. Regardless of whether you are taking fewer trips to the movies or using public transportation to get to work, you still need to heat your home. Recession or not, nobody is going to willingly turn themselves into a Popsicle to save a few bucks. And knowing what I do about futures traders, as soon as their little ears start to freeze running to the exchanges they will think twice about shorting oil.

Well that's all fine and dandy, but how can we play this without leasing a $30,000? NYMEX seat and trading oil futures? We can play it a couple of ways, I prefer to use the USO, which is an ETF that tracks the price of oil and is fairly liquid and has options as well. I like to sell puts 1-3% below the current trading price as a way to get the stock (and thereby the commodity) at a discount. I am not bright enough to pick the absolute bottom so I trickle trades in as it goes lower and bring my average purchase price down. As it turns back upward, the puts I have sold and not received stock also help bring my average price down nicely. I started this a couple of weeks ago and was unexpectedly rewarded by the turmoil in the Gaza Strip as oil prices popped a bit, but they are now coming back down so I like the levels and the trade again. I consider it a hedge for my heating bill and constant shuttling of my kids to practices, games, and so on...

Good Luck and Happy Trading!!

thinkorswim, Inc. and its registered employee, Steve Quirk, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.