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Get Ready for a Breakout in Oil Prices

Matt Zeman

NEW YORK (TheStreet) -- January crude oil futures have been little changed on the daily chart for several weeks now. Since late October, the market has held a range of about $85 to $90 per barrel. As I have previously said, in my experience oil does not tend to stay quiet for very long, and when it decides to move, the price action can be quite volatile -- and unforgiving to unsuspecting traders.
Although the market may be content continuing to hold this range until the end of the year, I feel strongly it is only a matter of time before we see a sizable breakout. The biggest question is: In which direction? Unfortunately I do not have a crystal ball and cannot see the future any better than you can.
Until this morning, I would have given the edge to the bulls, as the market, although still range-bound, has been making higher highs and higher lows. Crude is seeing selling pressure this morning, and depending on how oil finishes the session today, that bullish bias may or may not be intact.

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As of now, however, oil is back in no man's land in the middle of its current range. At-the-money implied volatility is trading under 27% (as of yesterday), clearly at the low end of the range. Looking at the OVX, implied volatility there, too, is at the bottom of its range, trading in the 29 area as of yesterday. This tells me it's time to get long volatility.
So how does one play the breakout here? There are numerous ways. If trading futures, one can simply wait for the break from the range and let price action determine the trade. In other words, be patient and let the market "decide" which way it's going to go.
Simply look to get long on a breakout to the upside and look to get short on a break to the downside. This can be done manually or with resting stop orders. Secondly, one can look for confirmation of the breakout. In this regard, one will look for multiple closes outside of the previous range and look to buy or sell on the first pullback.

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Options may be used as well. An investor may purchase strangles or straddles to attempt to profit from the breakout should it materialize.
Long options may also potentially profit from an increase in implied volatility regardless of market direction.
I believe we will see a "measured move" once prices break out. Because the market has been stuck in a $5 trading range, I will look for a minimum of a $5 move above the top of the range or below the bottom of the range. Positions may be scaled out of accordingly.
How one goes about it is a matter of personal preference, risk tolerance and trading style. Feel free to email me to discuss any questions you may have or how to structure a trade for you based on your market views. Please note today is Dec. 6, and all trade data is based on the most recent information. Please visit my Web site and download my free e-book The A to Zeman Guide to Option Selling to learn more about options trading theory and techniques.
Futures and options trading is inherently risky and unsuitable for all investors. Past performance is not necessarily indicative of future results. Stop-loss orders intended to limit losses to certain amounts may not be effective because market conditions may make it impossible to execute such orders.
Commodity Futures Trading Commission disclosure for licensed brokers: This material is conveyed as a solicitation for entering into a derivatives transaction.

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