Longtime reader, first DD post for me. Like the rest of you, I see the writing on the wall with the spiking cases in Florida, Arizona, California, Texas (I am in Houston), etc. and want to profit from the next market move. I believe many of these states will be slow to respond with effective quarantine measures, and anecdotally I have seen very limited compliance with social distancing and mask guidelines. Due to the long incubation period of SARS-CoV-2, the case count spike we are seeing is most likely from exposure 2-3 weeks ago, and opportunities for spread have only increased since then. Additionally, a large percentage of the population is unable to interpret widely available public data and believes the increased case count is a fabrication because “we are testing more”. However, a linear regression of the data for Texas shows the percent of tests that come back positive has increased from an average of ~4% 30 days ago to ~12% now, while the average number of tests have only increased by 10-20%. It is very clear from the data that we are seeing community spread at an exponential rate. Many will not come to this realization and alter their behavior until one of their loved ones becomes very sick. This will allow several more weeks of community spread to go on before R0 is brought back below 1. If the death count gets high enough, fear will take over and many will shelter in place again, either voluntarily or by mandate. The V-shaped recovery thesis becomes much harder to defend at this point, to say the least.
For those of you still reading, you are probably thinking “I know all of this, how do I make those sweet, sweet tendies?”. Most of you are banking on SPY puts, but I think you might have better odds at a roulette table. The Fed has killed price discovery, and can severely restrict the risk/reward ratio of bearish positions with literally an infinite arsenal. The retail investors know this and will buy any dips, and any new shelter-in-place orders gives Jerome a fantastic excuse to fire up the digital printer again. Don’t fight the Fed, and don’t bet against a retail-mania driven bubble. However, the Fed is not interested in propping up the price of oil (gasp!).
West Texas Crude dropped from a pre-COVID high of $65/bbl to futures at negative $37/bbl as a result of the demand destruction from worldwide quarantines. During this same period, an ETF that inversely tracks crude at a 2x clip, SCO, went from $12 to an intra-day peak of $67. SCO spiked twice more in the following days as crude underwent wild price swings. Fast-forward to today. Crude just formed a double-top chart pattern $40.50, exactly at the 61.8% Fibonacci Retracement level from it’s January 2020 peak to it’s April 20th low. This all-time low occurred an entire month after SPY bottomed on March 23rd, and this is because crude prices are actually driven by…wait for it…supply and demand. In other words, crude is still driven by fundamentals, while the stock market is (currently) not. In fact, government bailouts of the struggling US shale oil companies would only allow them to continue to flood the market, further driving down the price of oil.
The US Energy Information Administration has forecasted 2H 2020 crude prices to average $37/bbl based on a V-shaped recovery (www.eia.gov/outlooks/steo/report/global_oil.php). We are currently at $40/ bbl based on OPEC+ compliance and recovery optimism, and we aren’t even into Q3. There are too many variables for me to accurately predict actual crude demand in a W-shaped scenario as subsequent infection spikes slow the world’s energy demands down again, but a gain in crude stocks will immediately send prices falling. I would expect crude to look for support near the 50% retracement level around $32/bbl, which would push SCO approximately 40% higher than current due to the daily compounded 2x leverage. Another wave of government mandated lockdowns would likely see crude fall to $25 or below, which would put SCO at around $44. Another Oil-geddon scenario would put SCO -at $60 or more.
Nothing boosts oil prices like a foreign conflict, and tensions have certainly been on the rise this year. An airstrike on a tanker would be a bad headline for this position. If I am missing any other risks, please let me know.
COV-SARS-2 is once again pressuring global energy demand. The Fed can screw your SPY puts, but might actually hurt oil prices. Go long on SCO or go with UCO puts. Choose expiration and strike price per your risk tolerance.
Buying SCO directly will decouple the risk associated with trying to time the market. But I know how safe you guys like to play it, so load up on those puts!
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.