Back On The Oil Short

El-Badri deserves a hell of a lot of credit. He’s orchestrated a near doubling in oil prices without any substantive agreement, policy change or even a lie! Absolutely nothing has changed since November 2014:

  • The Saudis still wants to assert dominance over Iran, maintain market-share and stick it to low-cost producers – er, US frackers
  • All producers still want higher prices and yet, none have agreed to cut production
  • Those complaining the loudest – Venezuela, Ecuador, Nigeria and Russia, are still every bit as unable to cut production as ever! Just look to Russia’s premature withdrawal from Syria due to the mission being “generally accomplished.” This is entirely uncharacteristic of Putin and wholly a transparent consequence of Russian liquidity problems

What’s more, ensuing dollar strength should be a big surprise to the market, as inflation accelerates and encouraging US macro data pushes markets to fully-price in three and possibly even some of a fourth hike. While, believe it or not, no correlation actually exists between dollar strength and oil prices, this should help reverse sentiment on commodities, more broadly – especially gold!

Until we see some signs of a breakdown in crude futures, I don’t want to short the futures directly or even through options – I’ve been burned too many times fighting oil’s ascent. Additionally, I’d like to get some short exposure to equities. To that end, I’m looking for stocks that have high exposure to oil prices and are highly volatile, but not too expensive.

To screen, I looked for stocks with the largest intraday high-low ranges, as a percentage, over the last 50-days that are:

  • Energy stocks in S&P 1500
  • Currently trading above $10
  • Optionable
  • Downward sloping 50-day moving average

The candidates included: $UNT, $SM, $WMB, $GEOS, $BRS, $MRO, $ESV and $QEP

I compared each stock’s correlation and beta with respect to the front-month crude contract, as well as each stock’s current implied volatility, versus its prior 52 week range.Screen Shot 2016-03-22 at 8.50.54 AM

While $UNT, $SM, $MRO and $QEP had very strong correlations with crude prices, only $UNT and $SM had betas larger than 1.0. Unsurprisingly, these names were also among the most expensive, relative to their less volatile peers.

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I ran a relatively simple options analysis where I assumed a modest 15% decline in crude over the next two weeks and priced the highest OI, OTM – relative to each stock’s implied beta target, APR strike puts for each name.

 

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Ultimately, only $UNT and $SM produced positive returns at their beta implied target prices over the next two weeks. Note: $GEOS and $BRS options weren’t liquid enough to obtain reliable pricing.

I’m looking to open APR 7.5 PUTS in $UNT over the next couple of days.

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