Profit but avoid being caught in an oil slick

IF YOU thought that you were nursing a financial hangover from last week’s commodity crash, spare a thought for Clive Capital. The world’s largest commodity hedge fund was left with losses of more than $400m (£240m) after being caught short (or long as the case may be) in the oil price collapse on Thursday.

Moves of last week’s magnitude are rare – Brent shifted in a 2 standard deviation move and Texas light sweet had a 4 standard deviation move – but when they do happen, they hit investors hard.

If you lost money in the crash, it may be of scant consolation that you find yourself in the same club as Clive Capital as well as others such as Astenbeck Capital, who made percentage losses running into double digits. But, as the losses reported by hedge fund giants show, whether managing $5bn like Clive Capital or £1,000 worth of CFD margin payments, measures to limit downsides are essential.

One of the key ways of limiting losses is through a trailing stop loss. This is a level that automatically adjusts higher or lower as the underlying stock fluctuates. For example, if you place a 50-point trailing stop loss on the S&P 500 and you go long at 1,340, the stop loss is at 1,290. If the index moves up to 1,450, the stop loss moves up to 1,400. The advantage of using this system is that if a crash happens while you are taking a long lunch in Bonds, you won’t lose your (pinstripe) shirt, but it allows you to lock in any profits made so that you can pay the bill when it comes.

As well as stop losses, David Jones, chief market strategist for IG Index, suggests that you could take a position on far away options on oil, but warns that this could be expensive due to the increase in volatility: “At the moment for example, if you held a quantity of oil stocks, you could buy a July Crude put at 9600, for 260 points, so you would make some back if the price absolutely collapsed. This would need to be below $93.40 ($96.00 minus the $2.60 cost of put) to make money at expiry, which is 16 June – bearing in mind that oil differs from other futures as it expires before the actual contract month.”

After their crude awakening, traders may be wary of heading back into oil. But with the right stops in place, they can limit their potential for losses while taking advantage of the upward trend that many expect to continue.