Last week’s missive spotlighted the sudden resurgence of volatility in the oil patch. Today I want to pick-up on the theme and layout one-way traders might try to capitalize on the situation. If you can come away from today’s tale with a better understanding of how to take advantage of higher implied volatility with naked puts and how to trade an oversold stock, then I’ll consider my mission accomplished.

First, the monkey-hammering taking place in oil and energy stocks has volatility seekers flocking to the sector in droves. In today’s zero volatility world, any whiff of excitement gets thrown center stage. The fact that the volatility surge struck oil is particularly helpful since year-to-date the popular commodity has been deader than a doornail.

At yesterday’s low, the crude correction reached a 14% drawdown.

Here’s a pro-tip. When any major asset class sitting in a weekly uptrend drops 10% to 20% in two weeks, dipping your toes in the water is a must; particularly if a large implied volatility spike accompanies the swoon. You’re getting paid a pretty penny to take risk at that point.

USO fit the bill on both fronts. Its implied volatility rank jumped to a three-month high while its price reached deeply oversold territory. I even threw it in last week’s options report as one to watch for a rebound. I’m not a huge fan of going against the trend, but the few times I do are when the stock is stretched, and option premiums are pumped.

My weapon of choice to trade this type of setup is selling out-of-the-money puts. The first two April OTM strikes for USO are the $10 and $9.50 puts. The $10 was a bit too close for comfort, but I reasoned the $9.50 gave me enough margin of error to justify selling them. For most of the sell-off, they were trading sub-20 cents. Now, I have a personal rule that I want at least 20 cents when I sell an option to make it worth my while. So I decided to make the market come to me by placing a limit order to sell the Apr $9.50 puts at 20 cents or better.

They finally triggered in yesterday.

To increase my odds of success, I have additional dry powder (read: capital) to sell more 9.50 puts at, say, 30 cents, if the downturn persists. If we can get a reasonable bounce, I’m also looking to roll these naked puts into a strangle by selling the Apr 11 calls. We’ll have to see their premiums rise to 20 cents before it’s an attractive adjustment, though.

Worst case scenario, USO will sit below my expiration break-even of $9.30 and I’ll have to decide if I want to take a loss, roll out to May to re-up the trade for another month, or allow assignment and acquire shares for some good old covered call selling.

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