3 Trades to Capitalize on Secular Trends in Energy Markets

by: Simon Monger

One of the major themes at the Independent Petroleum Association of America Oil & Gas Investment Symposium this year was the shift from natural gas into liquid-rich assets like crude oil. The secular shift is being largely driven by enormous shale gas reserves and the rapidly rising price of crude oil due to trouble in the Middle East and rising demand worldwide.

Profit from Higher Oil by Focusing on Equipment

The rapidly rising price of crude oil has led many oil and gas companies to shift their focus on liquid-rich assets like crude oil instead of natural gas. Moreover, the higher prices make it more economical to drill in locations that have previously been considered too pricey. While these exploration companies stand to profit over the long-term, it’s the oil equipment stocks that could benefit in the short-term.

Traders can capitalize on the short-term moves in oil equipment stocks by playing larger individual names like Baker Hughes Inc. (NYSE:BHI) or Schlumberger Limited (NYSE:SLB) or by seeking out oil equipment ETFs like the iShares Dow Jones US Oil Equipment ETF (NYSEARCA:IEZ). To isolate these short-term moves and take out macro-risk, traders may consider a pairs trade in which they go long these stocks and purchase a protective put in the S&P 500 using the SPDR S&P 500 ETF (NYSEARCA:SPY) or similarly broad indexes.

Investors looking to capitalize on long-term bullish trends in oil exploration and production companies may want to consider other conservative options strategies. For example, selling out-of-the-money call options against stock positions in larger E&P companies like Exxon Mobil Corporation (NYSE:XOM) or foreign companies like Petroleo Brasileiro SA (NYSE:PBR) could be a conservative way to place a prudently bullish bet.

Profit from Range-bound Natural Gas Prices

Many analysts expect natural gas prices to hover between $4.00 and $7.00 per mmbtu, but they also warn that some oil companies have reported profitable production at the low end. Consequently, traders can expect to see more downward pressure than upward pressure over the long-term, with some short-term upside blips due to temporary bullish inventory announcements.

Traders looking to profit from an equity trade can simply purchase at the low end of the bands and short-sell at the high end of the bands, but options traders may be more inclined to use a specific range-bound strategy. For example, a long iron condor strategy, (or, the combination of a bull put spread and bear call spread) pricing gas at these channel levels could offer significant upside.

One potential iron condor trade may look something like this:

  • Buy one 3900 June ’11 put @ 0.035 for a $3.50 debit.

  • Sell one 4000 June ’11 put @ 0.055 for a $5.50 credit.

  • Sell one 4900 June ’11 call @ 0.036 for a $3.60 credit.

  • Buy one 5000 June ’11 call @ 0.027 for a $2.70 debit.

The result is a $2.90 credit per trade with the maximum risk being the difference between any two strikes minus the net credit and the maximum reward being the net credit received. The same strategy can also be applied to natural gas securities like United States Natural Gas Fund, LP (NYSEARCA:UNG) or First Trust ISE Revere Natural Gas ETF (NYSEARCA:FCG), but these may not correlate directly with gas itself.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.