Worst to first – that's what traders seem to be hoping for energy stocks this quarter.
The sector began the year with a 7 percent drop, making it the ugliest duckling of the broader market. But it’s bounced since the second quarter began this week and now the options activity reflects hopes of further gains.
Buyers snapped up calls in companies like natural-gas driller Chesapeake Energy (NYSE: CHK), oil-servicing giant Halliburton (NYSE: HAL), and pipeline operator Energy Transfer Partners (NYSE: ETP). Volume was at least 5 times the monthly average in all three names.
Calls fix the price where securities can be purchased. They have the ability to generate leverage if a stock appreciates, but can lose all their value without a move higher.
Take CHK, which has clawed its way back to $6.11 after scraping below $5 last month. Sure, investors may feel queasy when they see its massive debt load and junk credit ratings (B- at S&P), but some may see a chance of conditions improving. How can they benefit from a rally while limiting their capital at risk?
To answer that question, traders bought more than 18,000 of the April 6.50 calls. They paid $0.10 to $0.29, so their break-evens are between $6.60 and $6.79. Anywhere above that level, and the profits pile up fast. A move to $7 (a 14 percent up in the shares) will roughly double the value of their calls. A 23 percent gain to $7.50 will triple their value and a 31 percent surge to $8 will inflate the options by 400 percent. The calls will go to zero if CHK doesn’t climb.
Source: OptionsHouse by E*TRADE
What if you want to play earnings? Some companies, like HAL, have options specially designed to match that kind of bet. The next quarterly report is scheduled for April 24, and yesterday traders targeted a rally into the event by amassing almost 24,000 of the 28-April 51.50 calls for $1.10 to $1.32. They’ll make money over roughly $52.80, double around $54, but also lose all their value without a move. HAL closed up 0.61 percent to $49.85.
Analysts attribute the energy sector’s turn to several factors. First, international supplies have tightened thanks to coordinated production cuts between Saudi Arabia and Russia.1 Second, some big investors seem to have regained interest in the sector.2 Third, energy companies are projected by some analysts to have the best profit growth this coming earnings season.3 Fourth, the global economy continues to improve.4
One thing that’s different about the current boom versus previous years is the rise of the United States as a major producer. That may have been the thought in the long-term bet that occurred in ETP, whose pipelines span the country's interior. The investor bought 15,600 January 2019 45 calls bought for $2 and sold a matching number of January 2019 55 calls for $0.90. Known as a vertical spread, the trade cost $1.10 up front and will return over 800 percent from a move to $55 by expiration almost two years from now. ETP rose 0.25 percent to $36.31. The spread will become worthless without a move above $45.
So, from several angles it looks like options traders are gearing up for an energy bull market to continue running.
1. Reuters: OPEC compliance with oil curbs rises in March as UAE joins cut: survey. 3/29/17.
2. Oilprice.com: The Largest-Ever Hard Assets Fund Bodes Well For Energy. 4/5/17.
3. Factset: Earnings Insight. 3/24/17
4. Business Insider: The European ecoomy just had its best quarter in almost 6 years. 4/5/17