Easy Trade for Oil Income

On February 2, 2015, I recommended a Bakken oil stock to a group of my readers. The stock was Oasis Petroleum (NYSE: OAS), and I’ve written about it before (here and here) in Wealth Daily.

It’s an interesting story, and I’d like to take you through the whole process of this trade: Why I was watching it, why I pulled the trigger when I did, and what I advised my readers to do when it ramped higher right after we bought it.

I know in my career, I’ve learned a lot by examining successful trades and long-term investments to find out what made them successful. And I think it’s a particularly good time to have a look at Oasis because some of the things that got us in the stock in the first place are starting to show up in the chart again. Another big move higher may be coming very soon…

Let’s start with the fundamentals.

As I said, Oasis is an oil company working the Bakken shale oil field. So yeah, its share price has been crushed along with all oil stocks.

I normally don’t mess with huge sell-offs because they are typically very difficult to get right, and you can (will?) lose a lot of loot if you don’t get it right. But the situation with oil is a bit different…

In a very general sense, the companies aren’t as important as the price of oil.

And oil prices will eventually go a lot higher than $50…

Because oil is a depleting resource. Fields are constantly in decline. And globally, something around 5% of current supply is lost to depletion every year.

Chevron (NYSE: CVX) says that 200 billion new barrels of oil have to come online between now and 2030 to meet demand.

Supply Problems Ahead

You may remember when oil shot up to $147 during the summer of 2008. Part of the reason that happened was that some new production was halted as the financial crisis hit.

Oil companies decided to hold on to their liquidity when it became apparent that the U.S. economy was in trouble and banks might stop lending. It didn’t take long for a drop in production to push oil prices through the roof.

So now, the Saudi plan to crush U.S. shale oil companies like Oasis by pushing prices lower is more than a little ironic. Because forcing companies to take production offline sets the stage for supply problems in the near future.

That’s why the CEO of Italian oil company ENI told Reuters: “If you are cutting capex (capital expenditure) drastically now — we can have a lack of production in four or five years creating a new increased oil price at $200 maybe.”

OPEC’s Secretary General recently said the same thing: “If you don’t invest in oil and gas, you will see more than $200.”

It’s also why Saudi Arabia is drilling new wells right now.

So that’s the backstory for oil. And as one of the premier Bakken companies, Oasis should be a good way to play an oil rebound if/when it gets going…

There’s the Rub

Once you’ve zeroed in on a stock that should be good for some upside, you’ve got to think about timing — especially when you need an outside catalyst (in this case, oil prices) to get the stock price moving.

So let’s go to a chart and see how Oasis has been trading. First the plain chart:

Now the one I “drew” to show you a couple things (you are free to make fun of my drawing, I know it’s terrible):

One note on this chart: The histogram at the bottom is volume. The pinkish bars are down days, and the dark ones are up days.

Now, as you can see, Oasis went into a free fall after Saudi Arabia said it would not cut oil production on November 27, 2014. Every oil stock chart looks like this.

Now, let’s take the events I’ve circled in order…

1. The Freefall: Nasty decline — never buy these sell-offs. Sure, there will be a bounce, but you don’t know where the selling will stop. Attempting to buy declines like this is called “catching the falling knife.” As that implies, it’s a bad idea and can hurt you if your timing is even a little off.

Trading Tip: Once the buying clearly stops, there can be a trade, but the stock price will rarely go straight up after a decline that steep. They call these “dead cat bounces.”

2. The First Sign of Buying: The share price was muddling around, doing very little, when all of a sudden there was a mad rush to buy it when it hit $12.50. You can see the huge volume spike. That day got my attention. There were buyers ready to pounce.

Trading Tip: Again, it’s not necessary to buy the first show of strength after the dead cat bounce. But you should be on your guard, because the next sign of strength could be the one that sticks.

3. The Tradable Run: Notice how the share price moved back to $12.50. That price is now clear support (a place where buyers step in and “support” the price). Also notice how the selling volume picks up, as indicated by the larger red bars. You should note that the price keeps stopping at $12.50, even though the selling is getting stronger.

Finally, the share price drops below $12.50 but recovers the same day to close above it. That should put you on high alert — it appears the sellers are unable to take it lower and the buyers are winning. Next step: buy the breakout.

Trading Tip: Breakouts aren’t easy to get right. As you can see on the chart, Oasis made many breakout attempts that failed. I recommended Oasis to Real Income Trader subscribers on February 2, after the stock had closed well above support at $12.50. The result was a massive break higher.

4. The Second Chance: It’s not at all unusual to see a stock break higher and then fall back to previous support. That’s especially true when the stock is trading on an outside catalyst (oil prices). Once the share price falls back, you start the process all over. The first big advance with strong volume should get your attention.

Trading Tip: Again, it’s usually not necessary to buy the first sign of strength after a sell-off. These are called “bull traps” because buyers that missed the first run higher will be too eager to buy the stock and jump on the first sign of strength. The eager bulls get trapped when the stock gaps down the next day. Patience is always a virtue.

5. Another Tradable Run Begins???: Question marks here because we can’t be sure, but there are signs another run is building. Notice that the first time the stock came back to $12.50, it jumped strongly. Buyers were waiting. A few days later, after a sharp sell-off (red bar), buyers stepped in at $12.50 again. The stock has yet to drop back to $12.50 and has an upward bias that may result in an imminent run higher.

Trading Tip: Yesterday’s move higher for Oasis came on very light volume. That is not a good sign that the breakout will continue. We want to see strong volume on the up days — the kind that would scare any sellers and attract more buyers.

So that’s my analysis on how Oasis has traded. Now let’s look at the future for a minute…

Income Instead of Selling

I don’t want to dump Oasis. When oil turns, this stock is going to launch higher. Plus, as one of the best Bakken drillers, Oasis is absolutely a buyout candidate at these levels.

So instead of just selling the stock, taking the gains, and hoping for a new entry point on that last big run, I advised my Real Income Trader subscribers to take some immediate cash by selling covered call options against their stock. 

We took $1.30 a share in cash on that covered call sale, a bit less than 10% of our entry price. That’s not a bad profit for a couple days’ work, and we still hold the stock as we wait for the next run higher.

If you want to learn how to take regular cash income from stocks you own, check this out.

Until next time,

Until next time,

Briton Ryle

@BritonRyle on Twitter

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.