Hot Trade: Hedging Against Tail Risk in Crude Oil

Trading in out of the money call options in crude oil has been brisk in recent days as traders seek to hedge against a massive move higher in crude prices. The catalyst for such a move could be Iran following through on its threat to blockade the Strait of Hormuz in response to threats from the United States and its allies. Given the tensions in the Middle East, the thought that oil could spike to $125 or even $150 in a matter of days or weeks has crept into the market's collective consciousness. On Wednesday, however, the price action in crude suggests that market participants have already gotten over their black swan fears and are now just looking to get the hell out of crude - at whatever price. NYMEX crude contracts have plunged 5.21% to $94.92. It is basically a blood bath. The catalyst for the move lower in oil has been a decision by OPEC to hold its output levels steady along with a plunging euro currency which has created a decidedly "risk off" atmosphere. As a result, much of the recent froth in the crude market has dissipated in a matter of hours. Given the magnitude of the move, the out of the money call options that traders couldn't get enough of earlier in the week just got a lot cheaper. If you are so inclined to put on the "crude oil black swan trade," today is the time to do it. The commodities markets, in particular, are totally schizophrenic right now and today's plunge could be reversed in short order depending on headlines. ACTION ITEMS:

Bullish:
Traders who want to protect against upside tail risk in crude might want to consider the following trades:

• Purchasing out of the money call options on The United States Oil Fund ETF USO - They got a lot cheaper today.

• Purchasing out of the money call options on NYMEX crude futures contracts - consider the FEB 12 125 strike if you want to gain relatively cheap exposure to a "black swan" move.

• Purchasing oil sensitive stocks such as refiners like Valero VLO and Tesoro TSO

Bearish:
Traders who believe that oil will continue to fall may consider alternate positions:

• Selling call options on the United States Oil Fund ETF USO or on NYMEX futures contracts.

• Buying put options on the USO or NYMEX futures contracts or shorting an oil sensitive security outright.

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