Prepared by

Ira Epstein & Company

The energy complex appears to be in a bullish mode at the moment. Prices for January crude are hanging tough at some fairly high levels. The reasons for this appear to be twofold: (1) routine late autumn concern over heating oil supplies and (2) saber-rattling by the clownish “Saddam.” As I write this, Iraq is threatening to shoot down United States U2 flyovers. Of course, they lack a surface to air missile capable of reaching U2 altitudes, but reality probably means little to the guy who promised us “the mother of all battles.”

Could a Middle Eastern eruption send energy prices higher? Certainly. Is it likely? Before you decide, consider the following. Saddam has had a history of asserting Iraqi sovereignty and backing down for years. I'm betting that even the states perceived to be tolerant of Hussein (France and Russia) will have sense enough (eventually) to realize that this guy is trying to stockpile nerve gas–a weapon arguably much more dangerous than nuclear arms. And faced with a reunited front, he should back down as usual.

Which leaves strong energy demand due to a cold winter as a supporting factor for the energy markets. The only problem with this scenario is that winter itself is not going to surprise these markets: its been happening for years. So part of the current lofty price level can be attributed to anticipated excessive demand which may never materialize.

Admittedly, there is significant risk in playing the downside of these markets. Don't do so without limiting the risk as in a vertical put spread:

Recommendation:

Buy a January crude 2100 put at approximately 90 points.

Sell a January crude 1950 put at approximately 40 points.

The net cost and total risk of such a trade is approximately $600 (50 points plus two commissions). Maximum gain (at the 1950 level) is about $1400. These risk /reward numbers can be improved upon with some fortuitous legging into and out of the various possible alternative positions.

November 3, 1997Tim Zurick

Ira Epstein & Company

223 West Jackson, 7th Floor, Chicago, Illinois

Spread Trading
The Spread Trader
Consensus National Futures and Financial On Line Index

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