When investing in oil you have the option of buying oil companies, ETFs, or futures, but long-term option investments may be the best play of the group.
Investing in oil relies on more than just consumer demand. You’ll contend with high day-to-day volatility that attempts to price in weather-related supply disruptions, OPEC price-setting, plus the fortunes of individual small or medium-sized oil producers.
For investors looking to increase their portfolios’ exposure to crude, buying individual stocks is one of several options. While large producers may afford more stability for investors, they’re unlikely to generate the type of return an investor may hope to receive from a speculative oil investment.
And while small and medium-sized oil stocks could generate higher returns, they’re also more susceptible to sustained depressed oil prices, which OPEC has been known to promote in order to squeeze out smaller U.S. domestic energy producers. Given these risks, picking the stocks that are most vulnerable to the whims of the market and those that represent growth opportunity can be a struggle.
Once considered a niche segment of the investing world, options trading has now gone mainstream.
With little knowledge on the best strategies, you can use options to work the odds in your favor and make trades that have up to an 80% probability of success. Find out how in this free report, How Options Work—and How to Hedge Portfolios with Options.Read Your Free Report Here.
Therefore, if you believe in the long-term prospects of oil and oil stocks, the best way to play them is through LEAP options. LEAPs stands for Long-term Equity Anticipation Securities. LEAPs are options that have several years until their expiration and are available for most indexes and stocks.
So if you feel that the recent drop in energy prices is temporary and that, long term, the fundamentals are strong for the oil sector, you could buy an option that expires in January of 2024.
As I said, figuring out which stocks are most susceptible to this fall in the price of oil is difficult. So if you want to put on a bullish trade in the oil sector, I would recommend using ETFs such as the Oil Services ETF (OIH) or Energy Select SPDR (XLE). When buying the ETF, you get exposure to a wide group of oil stocks rather than taking on the risk of choosing just one or two stocks.
For example, here are some of XLE’s holdings and weightings:
ExxonMobil: 22.26% weighting
Chevron: 21.26% weighting
EOG Resources: 4.59% weighting
ConocoPhilips: 4.49% weighting
So, as an example, if you wanted to buy a LEAP on the XLE, you could buy the XLE January 60 Call that expires in January 2024 for around $5.50. This option gives the owner of the call just over two years for oil and oil stocks to resume their uptrend.
While the LEAP option doesn’t reduce the intrinsic risks of investing in oil, such as depressed consumer demand, OPEC pricing pressure, or a fundamental shift to green energy, it does reduce your exposure as an investor. The option investment gives you comparable upside exposure to oil while reducing your maximum risk and your capital outlay. Because this is an option trade, your purchase price will include a time and volatility premium, which is best considered the price paid for the aforementioned lower maximum risk and initial investment.
What’s your preferred method for adding crude exposure to your portfolio?
Jacob Mintz is a professional options trader and Chief Analyst of Cabot Options Trader. He uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can gain from following Jacob’s advice.Learn More
*This post has been updated from a previously published version.