Monday, September 19, 2005

Wrong on OIH but I Still Made a Little Money

A while back I opened up a put ratio spread in the OIH. I was short the 115 puts and long the 120 October puts in a 2:1 ratio. This was a bet that volatility in the oil service industry might decrease with a slightly bearish directional bias. I know it seems crazy to go short volatility on the OIH (or any stock for that matter) in this environment. My thinking was this. In the aftermath of Katrina it seemed like there was a lot of fear in the market regarding the price of oil. Furthermore it seemed like everyone was bullish on oil volatility. It was getting a lot of press and I thought things were probably as bad as they were going to get, and at that point more than likely things would be just fine (comparitively speaking) and that volatility and the price of oil might decrease. Basically I was thinking of a slow drift downwards off of the prices at that time. Since I don't have a futures account, I decided to use OIH as a rough proxy for my oil idea.My feeling was that the main danger was that the OIH might experience large upward gaps. I had very little fear of a large downside move. The nice thing about a put ratio spread is that it can be (and almost always is) constructed with no upside risk. The position was established for a small credit which I would get to keep if OIH closed above 120.

Well I turned out to be wrong on OIH. It has stayed volatile and generally been going up. Today it was up over 4 bucks. There is concern about this new hurricane off of the Flordia Keys, and I think there has been some M&A activity in the sector. Whatever the cause, I was clearly wrong. I should have gotten long volatility, and I should have been bullish instead of bearish. The nice thing is that OIH has gone up so much that today it was very close to the maximum upside credit for the position. So I closed out almost all of the spread today. The profit from the credit actually turns out to not be that bad of a ROI considering how long the position has been open. I left a small amount of the 115 short puts open, in an attempt to capture some more premium since I feel much more bullish on the sector now (which means it's probably going to go down since I'm almost always wrong when I try to guess the short-term direction of a stock) The position is now pretty bullish, but I am still short gamma which is probably unwise.

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