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|
|Occidental Petroleum Corporation||OXY||75||8.78||0.83||18.8|
|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|
|EOG Resources, Inc.||EOG||75||7.38||1.59||28.8|
|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|
|Rowan Companies, Inc.||RDC||20||3.74||6.56||62.2|
|Massey Energy Company||MEE||25||8.07||5.15||46.2|
|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