July 2, 2008

The higher Crude Oil goes, the more nervous I get...

More weakness in the US Dollar followed by a decrease in EIA Inventories this week is certainly a reason for new highs in the Crude Oil contract. I have this overwhelming suspicion that we have not seen what-will-be the all time high. Additionally, I suspect that a major pull-back is right around the corner. Double talk? Not really. Just a suspicion on my part that a new high will create a wave of profit taking soon.

First, I am not denying the power of the Crude Oil Bull Market, nor I do think there is anyone left on this planet who does. I think we will continue to see higher highs along with an expanded trading range.

As far as the expanded trading range is concerned, this is where it gets tricky. The expanded range is simply a function of making higher highs followed by quick sell-offs to a support level. The last two months of Crude Oil's trading has been a perfect example of this. Crude Oil struggled for the entire month of June to break through the $138.00 level, while at the same time rebounding off of the support level of $132.00 resulting in a $6.00 trading range. I think going forward from here we can expect to see Crude Oil attempt to trade at $145.00, but will also see it trading down to $138 without reversing it's up trend.

Do you remember not too long ago, when Crude Oil would NOT trade more than $6.00 in a given year?

My second thought revolves around the Crude Oil market having moved too far away from its moving averages. While this is certainly not a timing indicator, we all know that markets don't move straight up or straight down, for very long. Moving averages are a great indicator of support and resistance. It is uncanny how the markets always seem to meet up with the moving averages at some point. When is the question.

Last, the RBOB futures contracts have come out of Backwardation and are now in a "Forward Carrying" arrangement. Backwardation is when the price of a commodity is higher in the front delivery month of the commodity than it is for the next delivery month for the same contract. Backwardation is a pricing anomaly that occurs when demand for a commodity is extremely high or when the market is experiencing shortages in the short term. Forward Carrying is when the front delivery month is priced lower than the next delivery month. Forward Carrying is considered to be normal price action as it accounts for storage cost, price risk and insurance. When a market goes from being in Backwardation to Forward Carrying it indicates that either demand has fallen back to normal or shortages have been made up. This may not signal the top for the RBOB market, however it shows what I believe to be a shift in demand. Feel free to call me if you have any questions on this, 800-284-1065.

For the time being look for RBOB to continue to track closely to the Crude Oil market's movements.

Trade Recommendations

My recommendation for this week is simple. Do not to trade in the Energy Markets at this moment given the short trading week due to the Fourth of July Holiday. There is also a lot of information that will be released on Thursday that will have a direct effect on the US Dollar and with a shortened trading session on Thursday coupled with the US markets being closed while Asian and European ones are not closed, is simply too much risk to handle.

Crude Oil 136-138.50 Bull Call Spread.

This Spread should have been sold back to the market by now and should be profitable. If you are still long this spread, get out of it now.

To view the EIA's Weekly Petroleum Status report, click here: http://www.eia.doe.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/txt/wpsr.txt.

Crude Oil

$138.00 price level that was formerly the resistance in Crude Oil is now one of this market's support levels. The next upside target, which I think is more of a psychological target than anything else, is at the $145.00 price level. Be very cautious with these two numbers as they basically define a $7 trading range. While this market has not turned around and become bearish, I am not confident of its long term sustainability at this price level unless another shock hits the market.

The August RBOB contract is now the front month. Like Crude Oil, this market has not corrected very much and probably will not as long as Crude Oil trades between $138 and $145. What is extremely important to watch out for is that the RBOB contracts are no longer in Backwardation and have resumed trading in a Forward Carrying Charge market. This fundamentally means that demand has tapered off. From here I would expect to see quick and violent retracements. I would not be surprised to see a 20-30 cent sell-off.

Call me to discuss any questions you may have, 1-800-284-1065 or markp@iepstein.com.

Good Luck and Good Trading,

All charts provided on this report are courtesy of OST IraCharts. For a 30 day Free Trial of the OST IraChart software, contact me directly at 800-284-1065, or email me at markp@iepstein.com .

The Seasonal Chart was provided by Moore Research Center http://www.mrci.com/

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The Bull Call Spread is the simultaneous purchase of a call option and sale of another call option with a higher strike price. This spread is used in anticipation of the market going up in price. In general, your risk of loss on a Bull Call Spread is limited to the price you pay for the spread.

If the spread is held through expiration with the price of the underlying futures at or above the top strike price of the spread at the time of expiration, then the theoretical market value of this spread will be realized. On the date of expiration the option contracts will convert to futures contracts with an additional round turn commission incurred as a result. This spread does not have to be held until its expiration. Profits can be pulled or losses can be cut at any time during the life of this spread.

If the spread is held through expiration with the price of the underlying futures contract settlement above the lower strike price but under the higher strike price, the option with the lower strike price will convert to a Long Futures Contract and the option with the higher strike price will expire worthless. Your broker should be ready to "Short" the market before the close of the day session to offset any Long positions that will be assigned. By not closing out any Long positions, you are assuming the risk of being Long a futures contract. For that reason, I highly recommend working with a Broker to manage any option spread trades.

If the spread is held through expiration with the price of the underlying futures contract settlement is below the lower strike price, the value of the option spread will be Zero ($0.00), the price you paid for the option spread and all associated fees will lost.