Let us praise the markets for creating puts and calls. The three-year period of volatility in oil delivery prices has created all kinds of havoc in the energy sector and in the global economy. The volatility and large moves in oil prices have created a wealth of opportunity for options players.
Puts and calls have many purposes, including hedging of portfolios, although I trade them to create monthly income as part of an overall diversified long-term portfolio strategy. That’s the same approach I’ll be taking with options in my forthcoming stock advisory newsletter, The Liberty Portfolio.
It has been difficult to decide what to do with energy as oil prices have been moving around so much.
Whether you hold energy stocks right now or not, however, you can use puts and calls to either open positions, close positions or generate income and hold a position at the same time.
Energy Stocks: United States Oil Fund (USO)
The most obvious way to play oil directly is with the United States Oil Fund LP (ETF) (NYSEARCA:USO). Your choice with selling naked puts or covered calls depends on what you think the price of oil will do going forward a couple of months. Let’s say you are already long, but think oil prices may be topping in the short term. In this case, you could sell covered calls.
The Wednesday closing price for USO was $11.09. You could consider selling the Jan. 20 $11 covered calls for 58 cents. If the stock remains below $11, you hold onto USO stock and collect a very generous premium of 5.7% for a mere 44-day holding period, or about 47% annualized.
Maybe you don’t want to hold USO, but wouldn’t mind buying it a bit lower. You could sell the Jan. 20 $11 naked puts for 47 cents. In this case you get a 4.4% return. If USO stock falls below $11 on or before expiration, it can be put to you, so you get it at an effective price of $10.53.
Energy Stocks: Energy SPDR ETF (XLE)
Again, suppose one already owns diversified energy investments in the form of the Energy Select Sector SPDR ETF (NYSEARCA:XLE).
If one sells naked puts, and in time, the energy sector is weak, and the giant companies that compose this index are at lower prices, one would have a basket of great companies put to them, at decent long-term prices, by having XLE put to them.
If the sector continues to do well, one will capture upside with the premium by selling covered calls and have the stock called away. Of course, nothing would prevent an investor from simply buying more of the XLE ETF.
XLE closed Wednesday at $75.95. The Jan. 20 $76 puts sell for a $2.20. That is a 3% return. The Jan. 20 $76 calls sell for $1.70, or about 2.3%.
Energy Stocks: VanEck Oil Services ETF (OIH)
Now, for those of you who are a bit more aggressive, you can drill down (so to speak) into the oil services sector with the VanEck Vectors Oil Services ETF (NYSEARCA:OIH).
Because this ETF owns oil services stocks, they are more subject to price volatility than the explorer-producers. These companies aren’t small, but have much higher volatility than the actual price of oil itself. There’s more risk and more reward in using options on these stocks.
In this case, OIH closed on Wednesday at $34.10. Again, whether you choose puts or calls depends on where you think oil prices are going between now and expiration on Jan. 20.
The Jan. 20 $34 naked puts for $1.55. So first, you pick up a very generous premium of 4.5%. Alternatively, you could sell the Jan. 20 $34 covered calls, if you own the OIH ETF, for $1.20, and generate a 3.5% return.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.