Trading the Oil to Bonds Ratio

• Posted by Greg Harmon
• on June 20th, 2014

Rounding out the week it is time to look at a pairs trade. The components, US Treasuries, as measured by the ETF $TLT, and Crude Oil, using the ETF $USO as a proxy, are both at critical levels. The TLT is on support after a fall from resistance. Will it hold and reverse or fall further?

The USO ETF has had a series of runs higher followed by consolidating pullbacks. It is consolidating again but by moving sideways. Will it roll over or change it s character and continue higher?

When you look at the pair trade between them there is no need to know which is moving which way. The final chart below shows that the ratio of the USO to the TLT has been in a range between about 0.32 and 0.35 for nearly a year. It moves from the top tot he bottom and back again but that is a really tight range. The technicians have probably already noticed that it is at resistance again, but this time with some conflicting technical information. The long candle Thursday with no shadows on either end, a Marubozu, is very bullish and it is a bullish Engulfing candle to boot. This calls for more upside if confirmed higher Friday. But the last 6 days have

also formed an expanding wedge, which can be a reversal after a big run up. Neither pattern is a given that it will play out but the one that does can be played as a trade in the ratio. To to this, on a move higher over 0.35 go long 3 units of USO and short 1 of TLT. If it breaks lower under 0.345 go short 3 units of USO against 1 unit long of TLT.

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