The High Price of Oil

In less than four years, the price of oil has risen about 300%, or over $50 a barrel. The Light Crude Continuous Contract (of oil futures) hit an all-time high at $67.80 a barrel Friday, and closed the week at $67.40 a barrel. Persistently high oil prices will eventually slow economic growth, which in turn will cause oil prices to fall, ceritus paribus.

The two charts below are same period daily charts of SPX (S&P 500) and OIH (an oil ETF, which is a basket of oil stocks). Over 15% of SPX are energy & utility stocks. The two charts below show SPX started the recent rally about a month before OIH. Also, the charts imply, non-energy & utility stocks fell over the past week or so, while energy & utility stocks stayed high or rose further.

SPX held its 10 day MA until just over a week ago, while OIH continues to hold its 10 day MA. The Parabolic SARs (red dots) indicate SPX is on a sell signal, while OIH continues to maintain the buy signal. SPX would need to rise to about 1,242 3/4 to trigger a buy signal, and OIH would need to fall below 115 3/4 to trigger a sell signal (see upper left corner of chart).

Perhaps, the safe play would be to wait for OIH to close below its 10 day MA, or fall below the Parabolic SAR buy level. However, I believe, if oil tests $70 (e.g. next week or the following week), that will be the OIH sell signal, and perhaps an excellent opportunity to buy OIH Sep puts (or puts on overvalued oil stocks).

SPX has sold into weekends over the past three weeks, which is typically bear market behavior. However, next week is options expiration week. So, direction will be somewhat skewed next Friday. The following are current August Max Pain expirations: SPX 1,225 with the value of calls about three times the value of puts (which is bearish, since the put/call is a contrarian indicator). SPX closed at over 1,230 Friday. OEX (S&P 100) 570 with the value of puts over three times the value of calls (which is bullish). OEX closed at about 571 Friday. QQQQ 39 with the value of puts twice the value of calls. QQQQ closed at about 39 1/4 Friday. It's interesting that the OEX put/call is roughly the mirror image of the SPX put/call, which may suggest institutions, which tend to buy large cap stocks, are skeptical of a rising stock market.

Economic reports next week are: Mon: Empire State Index, Tue: CPI, Industrial Production, Capacity Utilization, Building Permits, and Housing Starts, Wed: PPI, Thu: Unemployment Claims, Leading Indicators, and Philadelphia Fed. Fri: None. Recent data showed slowing and above trend growth with disinflation. A higher Capacity Utilization Rate would indicate future inflation. The high price of oil tends to slow economic growth rather than cause inflation (in part, because the high price of oil is a tax on consumption, which lowers demand for non-energy goods).

The big play may be buying Sep puts when OIH and overvalued oil stocks bounce, because OIH may continue to lag SPX. Also, options expiration week tends to be volatile, and the trading range may continue. So, there may be several other excellent trading opportunities next week.

Charts available at PeakTrader.com Forum Index Market Overview section.

Arthur Albert Eckart is the founder and owner of PeakTrader. Arthur has worked for commercial banks, e.g. Wells Fargo, Banc One, and First Commerce Technologies, during the 1980s and 1990s. He has also worked for Janus Funds from 1999-00. Arthur Eckart has a BA & MA in Economics from the University of Colorado. He has worked on options portfolio optimization since 1998.

Mr Eckart has developed a comprehensive trading methodology using economics, portfolio optimization, and technical analysis to maximize return and minimize risk at the same time. This methodology has resulted in excellent returns with low risk over the past three years.