Investors Position for Further Weakness in Energy

Jan.26.10 | About: Energy Select (XLE)

by David Russell

Energy stocks have gotten knocked down along with the rest of the market in the last week, and investors are positioning for further downside using the XLE exchange-traded fund.

optionMONSTER's Depth Charge tracking program detected two bearish ratio-spread strategies on the Energy Select Sector SPDR, which includes integrated oil companies, independent producers, and oil-field service providers.

XLE Chart

In the first, an investor bought 10,000 February 56 puts for $1.18 and sold 20,000 February 53 puts for $0.43. The trade resulted in a net cost of $0.32 per put contract purchased. Then about two hours later, the strategy was repeated on half as many contracts for a net cost of $0.26.

The XLE rose 0.66 percent to $56.67 Monday and is down 4.4 percent in the last five sessions. If it declines another 6.5 percent to close at $53 on expiration, the ratio-spread buyers will pocket $3, more than five times what they paid.

However, because of the greater number of puts sold short, the profits will erode below $53 and turn to losses under $50. The trade may have been implemented by shareholders of energy stocks who are looking to hedge against a move lower.

Other investors wished to protect against a steeper correction, and bought about 4,000 February 50 puts on XLE for $0.21 and $0.22 against open interest of 1,407 contracts.

Puts outnumbered calls by 7 to 1 in the fund Monday, reflecting bearish sentiment in the name.

(Chart courtesy of tradeMONSTER)