How to Trade Oil Volatility

There are a number of ways to trade oil given these current conditions of uncertainty and high volatility, but not without some degree of risk, so Dan Cook of Nadex suggests an alternative method, a limited-risk contract called the Nadex Crude Oil spread.

Crude oil has been an ongoing story for months and months now. How long can it stay at these low levels? Even the top analysts are mixed on the way they think the market is heading. I have heard estimates from $20 a barrel in the next couple of months, to $50 per barrel in the same time frame.

The price of crude so far has found some support around the $28 level, hitting there in late January, before returning to $35 a week later, and then slipping back to that familiar $28 mark. As of this writing, we are right around the $33 level, and if the direction of the last few days holds, we may very well test the $35 level again.

At this point no one knows if we are developing a range as the market sorts out the medium- to long-term direction. If we test $35 again, will it break higher or again be repulsed and slip back into the upper 20s. The only thing that seems to be fairly certain is that volatility will likely remain elevated and the moves either way could be anything but gentle.

In these conditions of uncertainty and high volatility, how can we trade these markets?

One option is to simply trade oil futures. This may be fine for some, but considering just a one point move in the crude contract represents a $1000 gain or loss, it is just way too risky and costly for many to participate.

Another choice could be to trade options on the price of crude. With the heightened volatility though, the premium—if buying either calls or puts—is pretty high. You could, of course, try to sell premium, but the potential for the market to make a very big—and very costly—move against you is ever present.