Are energy bulls running under the radar?
09/13/17

Many eyes focused on technology yesterday, but another sector was flying beneath the radar.

Unless you live under a rock, you know that Apple (NASDAQ: AAPL) unveiled its latest iPhone halfway through the session: the most breath-taking redesign in a decade, with the biggest and brightest screen ever.1 But despite all that buzz, the tech giant failed to break out.

But, things were happening in the energy patch as options traders called bottoms in companies near long-term lows. The sector is surprisingly up more than 5 percent in the last three weeks following a brutal slide since the end of last year. What’s going on? Analysts point to hopes of Russia and Saudi Arabia extending production cuts. OPEC also reported its first output drop since March, and domestic rig counts are starting to level out.2

Diamond Offshore (NYSE: DO) has been off to the races with an 18 percent surge from mid-August. It’s exactly the kind of company that can move when the tide turns because it’s loaded with debt. So-called short interest, or bearish bets against the stock, also stands at more than 40 percent of its float.3 (That can “squeeze” shares higher as sellers hoping for a drop become forced buyers.)

Options volume spiked to more than triple its monthly average on Tuesday as traders sold 2,800 December 12.50 puts for $0.94. Most readers know that owning puts fix the price where a security can be sold, letting them profit when a drop occurs. But this time they sold them, so what does that mean? 

Just the opposite: The trader agrees to buy shares in the event of a selloff. They collected income upfront and accepted risk of a selloff down the road. Tuesday’s position will achieve maximum profit of about $263,000 if DO stays above $12.50 through expiration in late 2017. That’s $0.94 X 2,800 X 100 (each contract controls a round lot of shares). They’re also at risk of losing $280,000 every dollar the stock falls below that level, all the way down to zero.

Diamond Offshore (DO) 3/17/17 - 9/12/17 chart

Source: OptionsHouse by E*TRADE.

Other beaten-down names in the space are also clawing off their lows. Take Weatherford (NYSE: WFT), which saw four-fifths of its market cap go out the window over the last three years. Yesterday traders sold 10,000 November 4 puts for $0.34 looking for the company to hold levels last seen in early 1999. WFT climbed 5.01 percent to $4.19 yesterday. 

A third transaction was detected in fracking stock U.S. Silica (NYSE: SLCA). Some 3,000 January 40 puts were sold for $14.85 and a matching number of September 40s were bought for $12. It looks like the shorter-term contracts had already been sold and were bought back, so in this case a position was closed and rolled forward in time. 

Market veterans saw two common themes in the activity. First, all three transactions occurred in volatile servicing companies more sensitive to changes in sentiment. Second, they reflected confidence that there won’t be new lows as cold sets in.

Bottom line: Energy has taken a beating all year but some traders expect at least a few months of stability. 

 

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1. Barron's: Apple Shares Slip: ‘iPhone X’ for $999 To Ship Nov. 3rd. 9/12/17.

2. CNBC.com: Oil jumps as Russia and Saudi Arabia discuss extending output cut deal. 9/5/17. Oilprice.com: Oil Prices Rise As OPEC Oil Production Declines In August. 9/12/17. Reuters: U.S. oil drillers cut rigs for third week in four as recovery stalls: Baker Hughes. 9/8/7.

3. Yahoo Finance: Diamond Offshore Inc., Key Statistics. 9/12/17.