When the price of oil goes up, it becomes profitable for oil companies to dig deeper and seek unconventional sources of oil, searching even in the harshest of climates. This job, however, is not for the faint of heart and often gets outsourced to the oil services industry. The oil services industry is in the business of managing geological data, digging wells, building rigs, handling infrastructure and developing the technology needed for larger projects.
West Texas Intermediate crude oil has been on a tear for over a month, up about 30% since the Oct. 4 intraday low of $79.95. At Stutland Volatility Group, we continue to be bullish on oil and see the oil services industry set for a gusher of profits.
Instead of pinpointing one or two specific oil services companies, we are targeting the Oil Service HOLDRs (NYSE:OIH), an ETF that provides diversified exposure to the oil services industry, as the way to play this trend.
December is historically bullish for stocks and bearish for volatility. Implied volatility in the OIH Dec 120 Puts is in the neighborhood of 48%. We can take advantage of this elevated volatility and equally high option premiums by being a put seller.
Specifically, to monetize this view, we want to sell the OIH Dec 120 Puts for $3.30 with OIH trading here in the $130 area.
This trade profits if OIH closes on Dec. 16 above $116.70, currently 10.8% below Friday’s close. By selling a naked put, we are essentially getting paid to wait for OIH to return to a level that we see as an excellent buying opportunity.
Should OIH dip and we find ourselves obligated to buy the stock, we will do so happily, knowing that our basis in the ETF will be $116.70, a price at which we find OIH to be a great value.
Here’s a summary of the trade:
Stock/Index: OIH
Stock Price: $130.86
Option Play: Naked Short Put
Sell: OIH Dec 120 Put
Net Credit: $3.30
Downside Breakeven: $116.70 ($120 strike – $3.30 credit)
Max Profit: $3.30 (Premium received)
Max Loss: $116.70 ($120 per share, minus $3.30 collected upfront per share)
