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As oil sold off over 6% Tuesday, I was searching for some companies to buy on the dip. I decided to look at opening the position with the buy/write option strategy, as this would give me a return if oil rallies, as well as protect my position to the downside if oil continued to slide.

As recently stated on OptionMaestro.com, I believed oil would peak in early to mid July. However if we keep hearing of these "green shoots" and the stock market continues to rally, I believe oil could continue to rally as well, and as late as October in my opinion. I don't think $75 a barrel oil is out of the question, especially on the back of a weak dollar.

For this analysis I have gathered a list of the top forty energy stocks (by market cap) from the S&P 500 index. I will outline an option idea on each stock which will provide a return (if crude oil/the market keep rallying and the stock is assigned at expiration), as well as downside protection on the stock (in case the market happens to sell off).

I have also included 5 energy related ETFs. Therefore to understand this post, you'll need a general understanding of stock options. To learn more about options and, how options can help protect your portfolio, and allow you to speculate with less money up front; check out my book here.

All data as of market close Wednesday July 29, 2009.

The stocks are in order from greatest to least market cap. The first stock in the table below is Exxon Mobil (XOM) to understand how to read the table I'll give a worded example using XOM. The example assumes the stock was being purchased and immediately written out for the August options expiration.

Purchase Exxon Mobil (XOM) stock, and sell the in the money August 70 strike call option. The premium received from the call option would give a downside protection of 3.35%. If the stock is assigned at options expiration on August 22, 2009 the total return from this position would be 2.86%. The current options market is factoring in a 64.4% probability Exxon Mobil will be at or above 70 a share by the August options expiration.

Company Ticker Strike Return % Protection % Probability %
Exxon Mobil Corporation XOM 70 2.86 3.35 64.4
Chevron Corporation CVX 70 6.19 1.05 26.6
ConocoPhillips COP 45 6.14 1.14 26.1
Schlumberger Limited SLB 55 6.84 2.06 33.5
Occidental Petroleum Corporation OXY 75 8.78 0.83 18.8
Apache Corporation APA 80 5.30 2.63 40.9
Devon Energy Corporation DVN 60 9.87 1.39 25.9
Anadarko Petroleum Corporation APC 49 7.73 1.90 30.9
XTO Energy Inc. XTO 40 5.49 2.37 37.9
Marathon Oil Corporation MRO 32 6.12 2.43 40.4
Halliburton Company HAL 22 5.00 3.15 44.6
EOG Resources, Inc. EOG 75 7.38 1.59 28.8
Hess Corp. HES 55 7.95 1.60 27.9
National-Oilwell Varco, Inc. NOV 36 6.04 3.01 41.4
Southwestern Energy Company SWN 42 7.94 2.75 37.2
Chesapeake Energy Corporation CHK 21 6.32 4.28 46.7
Diamond Offshore Drilling, Inc. DO 95 6.53 1.74 31.6
Baker Hughes Incorporated BHI 40 5.70 2.95 41.5
Spectra Energy Corp. SE 17.5 1.63 2.99 61.1
Murphy Oil Corporation MUR 60 7.46 1.85 30.9
Noble Energy, Inc. NBL 60 7.57 1.68 29.5
Williams Companies, Inc. WMB 17.5 9.10 1.54 24.6
Valero Energy Corporation VLO 18 6.26 2.87 44.6
Peabody Energy Corporation BTU 33 6.49 4.04 46.5
Range Resources Corp. RRC 47.5 7.29 1.71 30.4
El Paso Corporation EP 10 6.15 3.59 44.1
Cameron International Corporation CAM 30 4.90 4.84 52
CONSOL Energy Inc. CNX 35 8.36 3.88 40.9
Ensco International Incorporated ESV 40 9.28 1.35 24.3
Smith International, Inc. SII 25 7.98 2.94 36.7
FMC Technologies, Inc. FTI 45 8.72 1.50 26.3
Nabors Industries Ltd. NBR 17.5 10.39 2.16 29.1
BJ Services Company BJS 14 5.99 3.65 45
Denbury Resources Inc. DNR 15 3.36 8.24 67.1
Cabot Oil & Gas Corporation COG 35 5.60 3.50 44.8
Pioneer Natural Resources PXD 30 15.05 1.33 19.4
Sunoco, Inc. SUN 25 5.53 2.27 38.7
Rowan Companies, Inc. RDC 20 3.74 6.56 62.2
Massey Energy Company MEE 25 8.07 5.15 46.2
Tesoro Corporation TSO 14 12.34 2.97 33.3
ETF Ticker Strike Return % Protection % Probability %
Energy Select Sector SPDR XLE 52 6.29 1.11 25.4
United States Natural Gas Fund, LP UNG 13 9.21 5.05 44.3
United States Oil Fund LP USO 35 7.05 2.48 36.2
ProShares Ultra DJ-UBS Crude Oil UCO 11 12.66 4.71 38.4
ProShares Ultra Oil & Gas DIG 29 7.44 3.23 39

All of these options expire on August 22; therefore the last trading day is Friday, August 21, 2009.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

This strategy will give protection if the market sells off, as well as provide a return if the market continues to rally. If the stock is not assigned, this strategy is a great way to create additional income for your portfolio. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.

Disclosure: Long DIG, HES, UCO

Source: Oil Takes a Dive; Is It Still Alive? 45 Option Strategies