Iran's intentions have been in the headlines, inspiring a rollercoaster ride in crude oil of late. On Tuesday, May 30, crude rallied about a $1 on news that Iran would press ahead with its nuclear research. News followed a session later that the U.S. would resume multilateral talks with Iran if it halts its nuclear program. On top of an announcement from OPEC that it would keep production at record levels, there seemed to be some reasons for profit-taking, sending crude oil prices down nearly $2 to under $71 a barrel on Wednesday, May 31.

For crude oil, the major fundamental influences on the market are inventory reports, geopolitical tensions, and high demand. Concerns that sanctions may result in a halt in shipments from Iran, the world's 5^th largest oil producer, has helped push crude oil up 19 percent this year. The U.S. suspects Iran's atomic plans are a cover for building a nuclear weapon, while Iran says its program is intended to produce energy for peaceful use. The United Nations Security Council and Germany plan to meet Thursday, June 1, to discuss the situation, and more volatility in the crude market could follow. Traders will be keenly watching headlines as officials from several nations, including the U.S., will discuss incentives for Iran to curb its nuclear program.

While the market will of course fluctuate with the headlines, in my opinion, the world has gotten used to $70 crude oil, and so far there is only minimal demand reduction and minimal rotation to alternative sources due to high prices. That's why I remain bullish on crude oil, and energy in general, and am recommending bullish strategies.

I see the charts supporting this viewpoint. From a technical standpoint, the 40-day moving average has been acting as resistance for crude oil in the past. Once the market breaks above that 40-day moving average, we have seen a continuation to the upside. Stochastics (at the bottom of the chart below) also support bullish price action.

Crude Oil

I recommend the August 75/80 crude oil bull call spread, which has 46 days to expiration. The spread is $1,500 at current market levels, with a defined potential gain of $5,000, and a defined risk of net cost for the spread (including your commission costs).

Why does a bull call spread like this one have a defined risk? With a short naked option, there is unlimited risk, but because you buy a closer-to-the money call than the one you are selling, that makes the risk defined. If at expiration the price of crude is above $80, that means the spread is maxed out at a $5,000 profit (exclusive of commissions). It doesn't matter if the market is at $80, $90, or even $100, it would be worth the same. As the market rallies, the price on the short option cannot be worth more than the closer-to-the-money option. The 75 call will always increase in value faster than, or equal to, the 80 call. Conversely, if the price of crude is under $75, you'd lose your original investment. There are pros and cons to this strategy. One advantage is that by selling the 80 call, the money you bring in helps pay for the 75 call, making your net cost lower. The disadvantage is that your potential gain is also defined.

You could also buy the 75 August call outright, but it would cost more, about $2,300 as of May 30. So that means your risk would be increased to $2,300, but your potential gain would be open-ended. If crude were to rise to $85, that option would be worth $10,000, and your net profit would be about $7,700, excluding commissions.

I think in the next 3-6 months we'll see $80 - $85 crude oil. Longer-term, in the next two or three years, I wouldn't be surprised to see $100 crude.

Unleaded Gas

Unleaded gas has been moving in conjunction with crude oil, with essentially the same fundamentals. We've also seen an active start to the driving season, and signs of active summer airline travel which should foster improved demand expectations. Given the global recovery, it wouldn't be surprising to see expanded airline schedules.

As far as a trading idea for this market, I'm recommending going long August unleaded gas futures on a pullback to $2.04/gallon with a stop-loss at $1.97 and a target at $2.33. Futures and options strategies can be complex and involve significant risk, and these markets can be volatile. You may want to work with a professional to discuss your unique needs, and risk profile.

Frank Cholly is a Senior Market Strategist with Lind Plus. For more information on this topic or others, he can be reached at 888-801-9302 or via email at fdcholly@lind-waldock.com.

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