Wow. If there ever was a time to be glad for puts and calls to exist, it’s now.
The havoc and volatility in oil prices has set all kind of stocks in motion — namely, the entire energy sector, and portions of the global economy.
Thank goodness for options.
Puts and calls have a lot of usefulness in general. I like to use them primarily to generate monthly income on top of whatever my long-term investments do on the income and capital gains side. Occasionally, I use puts and calls to hedge certain positions in particularly extraordinary circumstances.
Now, however, they come into play as not only doing both of the above, but also to help position your portfolio for when the situation in oil prices settles down.
As of now, it’s nerve-wracking to decide whether to go long or short energy plays. Long-term puts and calls, called LEAPs, will help. Here are a few plays I like right now.
Naked Puts on the United States Oil Fund LP (ETF) (USO)
Where might oil be in January 2016? Most pundits believe, and I am inclined to agree, that they are going to be at least around $65 by then, and possibly 20% to 30% higher. Oil traditionally has perked up after crashes like this, but it takes 12 to 18 months.
The best way to play this would be to sell naked puts against the United States Oil Fund LP (ETF) (USO). This means you are taking the position that oil will indeed be higher in January 2016. However, if it is lower, you’ll own shares in USO, an oil proxy. Even if oil prices are substantially lower, and you get USO put to you, I consider that a good thing. Oil will eventually rise to these levels again, and you can average down.
USO trades at $23.91. I suggest selling the Jan 2016 $23 put for $2.53. This earns you 11% while you wait for oil to resolve itself.
Puts and Calls on the Energy Select Sector SPDR (ETF)
Let’s say you already own investments in energy, such as the Energy Select Sector SPDR ETF (XLE), which I happen to own. I think I’m going to sell both puts and calls against the XLE.
With selling naked puts, if a year from now the entire energy sector is struggling and the behemoths that make up this index are at lower prices, I will be getting this basket of world-class companies at what I consider to be good prices when XLE gets put to me. If the sector recovers, I will have captured some upside with the premium by selling covered calls.
If the sector and oil prices improve, nothing stops me from buying more XLE.
XLE trades around $77. The Jan 2016 $77 puts sell for a whopping $8.15. That’s about 10.5%.
The January 2016 $77 calls sell for $7, or about 9%. So on a mere 100 shares investment of $7,700, I can collect $1,515 in premiums. Nice.
Puts and Calls on Market Vectors Oil Services ETF (OIH)
The more adventurous investors can take a look at the Market Vectors Oil Services ETF (OIH). This handles oil services companies, which are far more subject to oil price volatility than some of the giant explorer-producers. Not that these companies are small, either, but they are highly sensitive to movements in the price of that underlying commodity and must be approached with caution.
In this case, you have the OIH trading at $35.62. You could sell the Jan 2016 $35 puts for $4.40. Not only do you get a 12% return, you also have about a 2% buffer before you hit the strike price. If you want to get more conservative, you can sell the same expiration date but the $30 strike for $2.50.
That’s still a 7% return and much larger buffer.
Alternatively, you could sell the Jan 2016 $38 calls for $3, and pick up an 8% return with a large recovery necessary in OIL before the call gets potentially triggered.
As of this writing, Lawrence Meyers was long XLE. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at email@example.com and follow his tweets at @ichabodscranium.