USO Unusual Option Activity

Since last October, the option interest in the oil space has been decidedly bullish and energy ETFs like the United States Oil Fund LP (NYSEARCA: USO) have done well. However, the tide appears to have changed on Monday as put option activity in the fund surged. This places oil in an interesting position as the fundamentals have been strong but the valuation is stretched. This comes as the tide of liquidity, driving speculation, is beginning to reverse. This places oil and oil stock investors in the precarious position of wondering whether to take profits.

Oil Futures Term Structure

One of the bullish indications for oil and which has helped USO track oil prices is the futures term structure. The term structure can be characterized as either normal, contango or backwardation. Over the past few months, oil has been trading in backwardation. This is characterized by falling oil futures prices as you move out in time.

The oil futures term structure is trading in backwardation, which is an indication of a potential shortage. However, the price difference as you move out from the April to May contract has flattened over the past week. The shift could be a result of waning speculative interest and an early indication of a correction in oil prices. A continued flattening and eventual rising term structure would confirm the shift in supply/demand expectations.

USO Option Activity

Option volume on USO was nearly 2.5 times the average on Monday. The call volume about 1.9 times the average while put option activity was 3.2 times the average. As you breakdown the composition of the activity, the put volume was filled at the ask on over 77% of trades. That’s a strong indication of put option buying. The put-to-call ratio finished at 1.31, which is an example of the significant put option activity. Here’s a summary of the unusual option trades on USO:

• 59,162 26 MAR 21 $44 puts BOT in four prints @ $1.57 to $1.58

The $44 strike is ATM but the overall expectation of the volume is for a bearish near-term move in USO. The breakeven price for USO is $42.42 in the next 18 days.

USO Technicals

While oil prices are back to its 2020 high near $65, USO is trading at nearly half it’s 2020 high near $106.50. This is a result of the cost to roll the front-month oil futures contract. That negative pressure has been eased as oil has been trading in backwardation since last October. Any reversion back to a normal or contango market will cause USO to underperform oil.

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When doing technical analysis, the price history won’t be accurate using USO and so it’s always best to look at the oil futures continuous contract. Looking at the chart of /CL gives a much better read at the elevated price of oil and how it is trading relative to it’s history. Right now, it happens to be testing a major level of resistance.

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Conclusion

For those weighing whether this is a good time to look at taking profits in the energy space, the short answer based on today’s activity is yes. This certainly doesn’t mean that oil prices are about to collapse but is a strong indication that the risk and reward of being long energy in a significant way is likely gone. That’s especially true of oil and likely true for oil-producing stocks and service companies.