Crude oil prices have been on the rise amid ongoing concerns of tightening gasoline supplies and a few other geopolitical factors. Let's go over some fundamentals you should be aware of as an energy trader, then I'll offer some current strategies for trading energy futures.

Memorial Day typically marks the kick-off of the driving season, which runs through Labor Day in early September. AAA, the largest driving organization in the U.S., expects 38.3 million Americans to travel 50 miles or more this Memorial Day holiday, up 1.7 percent from last year. And that is just the start. While of course more driving in the summer does lead to more demand seasonally, the biggest reason for concern over gasoline supplies today is that U.S. refiners have not been able to keep up with demand going into this driving season.

Currently, refiners are running at 90 percent capacity, compared with a five-year average of 93 percent. We did have some refiners with problems start up early this week, and the crude oil market did reflect that with a pullback on Tuesday, May 22, 2007. However, there are still some supply concerns, and these are key to watch when you trade energy markets this time of year, given expectations for strong demand.

Watch inventory data, which comes out weekly from the Energy Information Administration. Gasoline stocks are hovering at 17-year lows for this time of year. A small rise in the weekly inventory reports is not going to resolve the tight supply situation, and I feel any corrections in the market should be short lived. The EIA is projecting an increase in the demand for crude oil of five million barrels within the next three years, and the National Oceanic and Atmospheric Association predicts the likelihood of above-normal hurricane activity is 75 percent this season. This same scenario is also being predicted by a couple other private forecasters. Any major storm activity in the Gulf of Mexico would disrupt this summer's supplies. And if there is damage to any refineries, this could cause longer-term supply problems, further tightening gas stocks.

Lastly, as an energy trader, geopolitical factors are also very important, and can create sizeable price swings. Nigerian crude is the preferred product of refiners, and in recent news, militants in Nigeria have said they would attack oil installations to cut exports. The escalating violence in Lebanon and other areas in the Middle East going on right now is also a concern. On Wednesday, May 23,  a contingency of U.S. warships and aircraft carriers entered the Persian Gulf  to conduct military exercises. These could factor into supply issues if Iran or other oil exporting countries decide to get involved.

To top that off, Kuwait recently dropped its currency peg to the U.S. dollar, and there is talk of other Middle Eastern countries doing the same. This would hurt the ability of the U.S. to purchase oil. There is also news from the Asian front recently that China has invested up to $3 billion in a private equity group, and speculators think they may be diversifying their portfolio into commodity holdings like oil. Chinese refiners are running full tilt to keep up with demand, so tight gasoline supplies are not just limited to the U.S.

As you can see, you have to think global when trading energy markets!

As I stated, we have seen some pullbacks in the energy markets this past month, and some of this can be attributed to longs taking profits, and the June contract going into expiration. So even though we may see lower prices for a while, I feel there is plenty of bullish news to contend with.

Trading Strategies

The question now is, how do we take advantage of this as a trader? You can consider futures or options. On the futures side, the July crude oil contract is currently trading around $65.60 per barrel. I would look to buy July around the next support level at $64.60, and place your protective stop at $63.70. If my strategy is successful, I would recommend taking profits around $67.10, which is right above recent highs.

Using options on the futures, I recommend buying calls and buying call spreads, and am looking at the August or September contracts. For August (expiration 7/17), the underlying futures are trading at about $66,60, so I'd recommend buying $68 calls. If you want something a little less pricey, consider the $70 strikes.  

In September (expiration 8/16), the underlying futures are trading around $67.50. I'd recommend buying $69 calls or $71 calls. You can also consider call spreads, which will limit your profit potential but will be a little less expensive. I recommend buying the September $69 call and selling the September $75 call for around 165 points. This trade has a limited profit potential of 600 points at current market levels. Feel free to give me a call if you have further questions regarding the crude markets, and for the latest pricing on the options I have mentioned.

Greg Milkovich is a Senior Market Strategist at Lind Plus, Lind-Waldock's broker-assisted division. He can be reached at 866-631-6216 or via email at gmilkovich@lind-waldock.com.

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