Transocean (RIG) Is Setting Up For A Bounce

RIG is Setting Up For a Bounce

Oil has been on a free fall since October after it was concluded that we are now producing more oil than the demand. This cut the oil price in half as it fell into the $40s. OPEC has remained strong in that they will not cut their production. OPEC had to make cuts in the past that caused them to lose on market share and they are not going to let that happen again.

Eight weeks of straight losses has put pressure on a wide range of oil related companies. Layoffs have been in the hundreds of thousands, capex spending has been cut, contracts have been broken and companies have begun to shut in rigs. Production if finally beginning to drop and demand is beginning to rise. Sales of light trucks and SUVs grew by 19.3% over the year in January while passenger cars grew at 7.7%. Gasoline demand in the United States grew by 500,000 barrels a day in January.

Saudi Arabia, who is the controlling interest in OPEC, has been satisfied with the way the markets are beginning to balance out. They have the ability to weather through short term losses in favor of long term gains.

In hindsight oil was in a bubble. $100 a barrel was allowing companies free range to do what they want and become over inflated. The market will reach a new equilibrium as companies begin to adjust. We figure oil will hover around $50-60 a barrel.

One of the companies that has been on the chopping block is RIG, Transocean LTD. In October 2014 their price was in the $30s and now they have settled in the $16s. There is a bottom being formed at $15. Short term and intermediate term trends are beginning to level out and even move higher according to the 20 and 50 day moving average.

Upon closer inspection we can also see volatility is at a high. Currently implied volatility is at 58% when it averages in the low-20s. When volatility is above its average and it looks like price movement is beginning to slow we want to be net short options. This is going to give us a good opportunity for a short put spread under our $15 floor.

The trade we are looking at is April 15/13 Short Put Spread for .50 credit. That means we are short the 15 strike and long the 13 strike. This will set up for a margin of 1.50 per spread and a max return of 33%. Our breakeven on this trade is $14.50.

We are not interested in holding this spread till expiration, which is 47 days away. We want to collect 50% of this credit, .25, and generate a return of 16%. If volatility begins to come in because realized volatility is or RIG begins to move higher we should have no trouble reaching our goal credit.

What if RIG does not cooperate? We want out of this position if RIG closes below $15. To us that is our hard support so a close below that is a bad sign that RIG will begin to move lower. Even if RIG does move lower we should still see volatility come in from its elevated state which will keep losses to a minimum.

(This is not an official trade for The Option Prophet Service)

Posted to The Option Prophet on Mar 01, 2015 — 8:03 PM
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