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Should We Be Getting Ready To Cover Our Shorts In Energy?

Summary Crude oil priced in gold is near a 30-year low. Crude oil priced in inflation-adjusted dollars tells another story. What are the crude/gas ratios and technicals telling us about our short positions? Getting paid to be patient while we wait for the bottom in energy markets and stocks. Now that oil and gasoline cost less than bottled water, maybe it’s time to start looking at covering our short positions. Don’t get me wrong; I’m not ready to use the L word just yet (long), but I can clearly see long positions on the horizon at lower levels. The downward spiral is still intact, but history has proved short-selling parties can’t last forever. Just how inexpensive is crude oil? Let’s look at the 30-year chart for a barrel of crude priced in gold. All-time high 0.15050 of an ounce, June 2008. All-time low 0.03322 of an ounce, July 1986. Current 0.03370 of an ounce, December 2015. 1986-2015 average, 0.69889. Distance from the all-time low priced in gold 0.00048 of an ounce or about 50 cents. Source & supporting data Federal Reserve data 1986-2105-cost-of-oil-priced-in-gold 1986-2015 oil gold ratio (oil normally trades above gold on this ratio) Source Federal Reserve Is $34.52 per barrel misleading if you look at the historical price action from 1993-2015 calculated in inflation-adjusted dollars? All-time high $147.27 per barrel, July 2008 ($162.34 in 2015 USD). All-time low $10.35 per barrel, December 1998 ($15.80 in 2015 USD). The 30-year average price for oil is $42.87 ($59.09 in 2015 USD). 2015 dollars generated using the bls.gov inflation calculator . Current cash oil price $34.52 per barrel Data source Chicago Mercantile Exchange The fundamentals are still weak The technicals are still weak Daily = downtrend Weekly = downtrend Monthly = downtrend The spread between a gallon WTI crude and wholesale gasoline is more than twice the historical average. 1990-2015 historical average, $0.2147 ($0.28 in 2015 dollars). Current 12-month rolling average = $0.4426. Spread between WTI crude and retail gasoline, better than average. 1990-2015 historical average is $0.8642 ($1.14 in 2015 USD). Current 12-month rolling average = $1.2612. Spread between wholesale and retail gasoline, consistent with the historical average. 1990-2015 historical average is $0.6496 ($0.86 in 2015 USD). Current 12-month rolling average = $0.8186. Where the futures market is pricing crude oil through December 2024. Ratios tell me to maintain shorts, technicals say stay short, futures markets indicate higher prices. One current crude oil position to track Short March 2016 deliver at $46.80, contract value $46,800. Deposit posted per contract = $15,000. Exchange margin per contract = $3,800. March 2016 is currently trading at $36.74, contract value $36,740. I’d like to cover these $46.80 shorts, reverse to long at $33.00. 1) To cover my $46.80 shorts, I’m going to write a put at the $33.00 strike , collecting $1.24 per barrel or $1,240 per contract (expires in 58 days). The only way my current $46.80 short can be “pulled” away is if the market falls from the current price of $36.74 down to $33.00. Should this occur, my short position would appreciate by another $3,740 per contract between now and 17 February 2016 expiration. If March delivery never goes down to $33.00, I keep the $1,240 put premium collected against my $46.80 short. 2) I’m also going to write another put at $33.00, collecting another $1,240. Again, if March 2016 WTI crude does not trade down to $33.00, I keep the $1,240 in time premium. If it does go below $33.00, I was paid $1,240 to enter a new long position at $33.00 or $3,740 per contract better than where the market is currently trading ($36.74), (yes, I’ll have to offset and roll the position in March). 3) If the market stays the same, I’ve collected $2,480 over the next 58 days on a position if delivered is worth $33,000. 4) If oil starts to rally, I can cover my $46.80 shorts and watch the $33.00 puts expire worthless (+$2,480). There are several other ways to offset my $46.80 shorts, example, writing an in-the-money put at $40.00 currently trading at $4.59, collecting $4,590 in premium ($920 in time value). On the upside, the current position is trading at $36.74 contract value $36,740 (1,000 barrel contract x $36.74 per barrel) or I’m getting paid 6.750% in total time value over the next 58 days to liquidate my $46.80 if the market goes down to $33.00. If $33.00 in put is hit, my gain on the trade = $13,800 per contract plus the collected time value of $2,480 for a total of $16,200. The margin I’m allocating on this position is $15,000 per contract ( exchange margin = $3,800 per contract). What this strategy has done is paid me 16.53% in option time value on my $15,000 deposit per contract to be patient over the next 58 days. Many traders don’t realize how collecting fat time premium can work for you. Let’s assume the market is right and crude oil bottoms at the current price of $36.74 (March 2016 delivery). Let’s assume you go long crude oil at $36.74, wrote an out-of-the-money call at $39.50, and the $39.50 call is trading at $1.59, then you’re collecting $1.59 per barrel, $1,590 per contract, $27.41 per day or $10,006 per year on a position that has a total value of $36,740. The time value writing out-of-the-money options = 27.23% in annual time premium collected or 66.70% on the $15,000 allocated to cover the $3,800 in exchange margin. We’re posting $11,200 more than is required by the exchange to minimize the probability of a call. Our margin for error without being in jeopardy of having a call is $11.20 a barrel plus whatever option premium collected; in this case, $1.59 for a total of $12.79. In order for us to be on call (in this example) March 2016, crude oil would need to fall below $23.95 a barrel between now and 17 February 2016 (58 days). Again, I’m not advocating getting in at $36.74, I’m using this as an example to show you how hefty the time premium is writing out-of-the-money calls to generate income against a long crude oil position. In this example, the only way your $36.80 position can be called away from us is at $39.50 for a $2.70 profit per barrel or $2,700 per contract. If it does not get called away, we’d keep the time premium against our long of $1,590 (+10.60% on the $15,000 deposit for 58 days). In my case, I’m writing the $33.00 put to get into a $33.00 long position collecting $1,240 in time value; if delivered at $33.00, I’ll write the $36.00 or $37.00 call against the delivered $33.00 long collecting another $1,000 to $2,500 against the $33.00 long (I will have to roll this position to forward delivery month). Energy Stocks Energy stocks might not be as sick as all the academic chatter generated by the tradeless master debaters. Sure, crude may go down to $20, maybe $10, who cares? There are defined risk strategies to capture the move in both crude and energy stocks if you’re up to speed and can handle the risk. Fact, over the next five years, the world will need energy and the additional products crude produces. Demand may go down, but population will increase, and there are scores of situations that could generate a nice rally in crude from the low $30s as well as energy stocks. Many of these energy stocks you can trade using the same strategy of writing puts to get in and calls to get out as I’ve explained in the crude oil example above. Word of caution, you have to watch your bid/ask spreads, make sure you get firm quotes on the bid/ask, match them up to your other desks and always use price orders. On the horizon, I see short covering and potential net new long positions entering in energy stocks. Yes, the charts still look ugly. If you want to be less aggressive, wait for the turn (change in trend) using something as simple as a Bollinger 20,2 and exponential moving average 9 on weekly data in the examples below. Exxon Mobil Corporation (NYSE: XOM ) BP p.l.c. (NYSE: BP ) Royal Dutch Shell plc (NYSE: RDS.A ) Chevron Corporation (NYSE: CVX ) Valero Energy Corporation (NYSE: VLO ) (no short on this) Petrobras – Petroleo Brasileiro S.A. (NYSE: PBR ) Marathon Petroleum Corp. (NYSE: MPC ) (no short on this) ConocoPhillips (NYSE: COP ) Suncor Energy, Inc. (NYSE: SU ) Total S.A. (NYSE: TOT ) Statoil ASA (NYSE: STO ) Yes, oil is inexpensive and appears to be moving lower, but the world still needs it. We will eventually find a bottom, might as well get paid on our short positions while we wait.

Consider Adding Some CRAK To Your Portfolio.

Summary The Market Vectors Oil Refiners ETF launched this week is a compelling play in the energy sector. I conduct a review of the ETF itself and the opportunities & risks associated with the ETF. I believe CRAK is worth considering because of its strong performance in comparison to other energy segments. In this article, I will be reviewing the new Market Vectors Oil Refiners ETF (Pending: CRAK ), which launched yesterday. I believe investors should consider adding some CRAK to their portfolio because the refiners have been the lone bright spot over the last year when oil prices have collapsed. The following chart from the CRAK fund profile page shows that refining and marketing stocks are the only sub-segment of the energy sector (NYSEARCA: XLE ), which has posted a positive return over the last year. Crack Spread One of the most important things to consider when looking at refining stocks is to look at the crack spread. The crack spread is the difference between the cost purchasing the crude oil and the price of the products that the crude oil is refined or “cracked” into. I created the following chart using the ThinkorSwim platform that has the crack spread plotted over the last two years, as well as the performance of Valero (NYSE: VLO ), which is one of the largest holdings in CRAK. The chart shows that over the last two years Valero’s performance [Blue Line] has been highly correlated to the crack spread. (click to enlarge) [Chart from ThinkorSwim Platform] Opportunity The opportunity for refining stocks is promising because crack spreads are higher than a year ago, which will show up in the form of year/year earnings growth. In a troubled energy environment where oil companies/drillers etc cannot earnings, the refiners stand out above other energy segments. Using Valero as an example, you can see in the chart below for the last four quarters, EPS has been trending upward, even as oil prices had fallen to near $40, went back to $60 and are now back at $40. As long as the crack spread remains somewhat stable at these elevated levels, the refiners will continue to outperform the rest of the energy sector. (click to enlarge) Risks The primary risk of CRAK is that it is highly concentrated within its top 10 holdings. The top 10 holdings account for nearly 65% of the portfolio, therefore when considering CRAK investors should be comfortable with this fact and the underlying companies that are in the top 10 holdings. Second, another item to watch for is currency risk. As the following chart from the portfolio analytics section of the CRAK fund page shows, CRAK has a large international currency exposure. With nearly 50% of CRAK priced in foreign currencies investors who are also, bullish on the dollar could potentially pair a purchase of CRAK with the small-hedged position in the PowerShares DB USD Bull ETF (NYSEARCA: UUP ) or the WisdomTree Bloomberg U.S. Dollar Bullish ETF (NYSEARCA: USDU ) to mitigate the foreign currency risk. Closing Thoughts In closing, because CRAK just launched this week and I believe it should be added to investors watch lists for a period to make sure there is interest in the product. If there is adequate volume and CRAK attracts assets the refiners are a compelling choice when considering investing in energy because they have performed very well during this tough energy environment in comparison to other energy sector segments. Disclaimer: See here . Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Share this article with a colleague