I am not a fan of shorting stocks. I prefer benefiting from positive ideas, but sometimes I see extended situations that are too tempting to ignore. ConocoPhillips (NYSE:COP) has had an incredible rally of late and that’s the focus of my write up.
So, today I want to attempt a bearish bet on COP, but without any out of the pocket expense. This is an uber-bullish equity market where shorting stocks is hazardous to one’s portfolio.
Clearly, I won’t be shorting the stock outright. I will use options instead because much like catching falling knives is dangerous, so is shorting shooting stars. ConocoPhillips is a star that should retrace lower soon.
Before you label me evil for shorting a rally, know that my last COP trade — back in May when everybody hated it — was a winning bullish trade. Typically, I prefer to enter bullish setups in oversold conditions. But the recent rally in energy prices has gone too far, too fast in my opinion.
The fundamentals of oil prices have not changed in months. Above $52 dollars per barrel, OPEC has the incentive to push it down. Otherwise, they’d lose the market share for which they fought really hard to regain in 2016.
There is a theory out there that this time it’s a little different because they want high energy prices during their IPO for The Saudi state oil company. I don’t yet believe that. So, in essence, I consider this a bet against oil prices more so than one against COP stock.
I decided to short an energy stock rather than an exchange-traded fund (ETF) like the Energy Select Sector SPDR (ETF) (NYSEARCA:XLE) because the energy stocks have gone much farther. ConocoPhillips is up 12% in a year whereas the XLE is down 3%.
Today’s trade is not a knock against the company as a whole. Meaning I don’t expect a complete disaster. However, I do want to short the price action of late.
Fundamentally, COP stock is not a screaming value case because it runs at a deficit. But from a price-to-book perspective, it’s not bloated either. So far, the company has been committed to the dividend and for as long as oil prices hold up it is likely to continue that.
Even though I can’t tangibly measure value from the price-to-earnings perspective, I am still willing to use the intrinsic value of ConocoPhillips to finance my bearish bet.
Ideally, I want the price to fall below my bearish put spread but stay above the bullish trade, which I consider to be the bank. Although this sounds like a spread-the-needle situation, it’s relatively easy to implement.
Bottom Line on COP Stock
The Bearish spread: Buy the COP Nov $48/$47 debit put spread for 28 cents. I want COP stock to fall through my spread to double my money.
To mitigate my risks, I will completely completely eliminate the out-of-pocket expense. To do that, I sell puts for income against proven support levels.
The Bank (bullish side): Sell the COP Jan $42.50 put, where I collect 45 cents to open. As long as the price is above this level, I retain maximum gains.
By taking both trades, I take in a net credit, so I am getting paid to place this bearish bet. I am a winner already. And as long as ConocoPhillips stays above $42.50, any premium I recover from selling the debit put spread would be pure profit. This is true even if I sell it for less than what I paid for it.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.