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The BP Oil Leak Trade

 May 24, 2010 04:32 PM

With crude oil being pressured and the BP plc (NYSE: BP) oil leak still flowing strong, the consensus is split on which direction we will trend next. On one side you have skeptics saying to get out before all the markets crash even though CNBC called a bottom last week.  Every day, it seems I am becoming more bearish (especially when CNBC calls a bottom) as I feel we could be one disaster away from a larger correction or possible crash.  This disaster could be another serious volcano disruption or more than likely a hurricane as the hurricane season starts next week.   If not a natural disaster, we still have the possibility of a collapse, reminiscent of Greece.  Some say China's economy might be significantly weaker than the media has been proclaiming, which would easily allow the bears to wreck havoc.  This wouldn't be the first time major media lead us in the wrong direction.  On the other side of the argument, you have contrarians loading up with the hopeful expectation that BP will fix the leak before the markets crash, if they actually do.  Crude oil has fallen lower, which I attribute to psychology rather than lack of global demand.  With that being said, if BP does fix this leak shortly, we could see a strong rally in crude.  This rally could slingshot many beaten oil stocks to new highs but time is against us in this trade.

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I am currently gambling on this oil trade and it has not been a trade for those with a weak stomach.  BP could still fail in their attempt, which is likely to send crude prices down another leg.  I have tight stops in place as not only could BP fail miserably, but we could see a market selloff before the fate of the leak is determined.  If a hurricane develops anytime soon, we would see the repair efforts halt and a bad situation turn worse.  Since I have been playing defensively over the past few weeks and now sitting in mostly cash, I feel as safe as I can doing this high risk/high reward oil trade.  Again, this is not a trade for those with a weak stomach.

When making a trade like this, it is many times safer to buy a basket of similar stocks rather than just one.  You could also use an ETF but I prefer to make my own prudent selections on which to buy and I prefer to stay in the explosive small-caps.  In this case, I am very bullish in Kodiak Oil (AMEX: KOG) and have been for quite some time to those who follow me.  KOG not only has fundamentals working in their favor but some of the technical's on the chart are still strong even with the recent PPS drop.

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