Sell Oil Stocks?

Written By Briton Ryle

Posted May 27, 2015

Jim Chanos is a short seller. That is, instead of buying stocks that he thinks will go higher, he sells stock that he thinks will go lower because of inherent fundamental problems.

He made a pretty good call on China three years ago when Chinese stocks were flying high…

At the time, China was putting up double-digit annual growth. Its export economy was booming. So was real estate. Chinese citizens were seeing their standard of living skyrocket, and they were spending.

Chanos called BS. He believed short-term debt was being invested in long-term assets (building factories, condos, etc.) and there would be a problem down the road.

Today, China’s debt problems are pretty well known. It’s likely there is a real estate bubble. But the Chinese economy hasn’t gone into crisis as Chanos once forecast. Still, the China Large-Cap ETF fell more than 30% before the recent rally. Chanos made out pretty well…

But I’m not sure his latest downside bet will pay off so well. Jim Chanos is telling anyone who will listen that he is short Big Oil and U.S. frackers.

Last week, he told “Wall Street Week” viewers that the fundamentals of the oil industry have changed. He said, “These guys like Exxon and Chevron and Royal Dutch Shell are simply replacing $20 [per barrel] oil with $80 oil.”

He’s right. Cheap oil that costs $20 a barrel to get out of the ground is gone. Oil from the Canadian oil sands costs at least $60 a barrel to produce. To get at the massive deepwater Brazilian oil fields, you have to get through 6,600 feet of water and another 16,000 feet of salt, sand, and rocks. It’s gonna cost a lot more than $20 a barrel to do that…

The most efficient U.S. shale wells can produce oil at around $45 a barrel.

So, yeah, clearly oil companies aren’t making as much money with oil prices at ~$60 a barrel as they were when oil was ~$100.

But I’m not sure I want to wager any loot that oil stock prices are going to head lower from here…

Know When to Fold ‘Em

The fact is, oil prices cannot stay at $60 forever. It’s a simple matter of supply and demand from Economics 101.

If you can’t sell something at a price that gives you a profit, then you’re not going to produce it. As oil prices squeeze profits, there is less incentive to pump more oil. That’s why drilling rig counts in the U.S. have fallen for 24 straight weeks.

Oil companies have decided that preserving cash is more important than producing marginally profitable oil, so fewer new wells are being drilled.

Lower oil production means oil supply will not grow like it has over the last few years, when $100 oil meant big profit margins. But the demand side of the equation — oil use — continues to grow 1% to 2% a year. That’s about 1.5 to 2 million barrels a day.

And the fact that the world loses around 5% of oil supply every single year from field depletion means the current oversupply will balance out pretty darn quickly.

How quickly? I don’t know. There are a lot of variables that make predicting the exact timing of a turn for oil prices difficult. And really, oil price have already rebounded nearly 40% — from $42 to $60 — because everyone knows the supply and demand situation will change in the future.

It really is just a question of when.

So what do you do? How do you prepare for a rebound in oil prices and oil stock prices when the timing is uncertain?

Get Paid to Wait

Of course, you could just buy high-quality oil stocks and wait for the inevitable rebound. That’s what many investors are doing right now.

But of course, if oil prices don’t recover this summer, or if it takes until next year to get some momentum for oil prices, those oil stocks aren’t going to do much. They might even trade lower, as Jim Chanos thinks.

I don’t know about you, but I damn sure don’t want to buy a stock that has a pretty good chance of trading 20% to 30% lower sometime in the next year. So here’s how you can get paid to wait for the real oil stock rebound…

You can buy an oil stock and then sell covered call options on that stock. Let me show you what I mean…

Back in February, I told my Real Income Trader subscribers to buy shares of Oasis Petroleum (NYSE: OAS) around $14 a share. A couple weeks later, we sold a covered call that netted us $1.30 a share.

Now, when you sell a call option, you’re entering into a contract to sell a stock at a certain price to the person who bought the call option.

So if you own the stock already, you’re simply agreeing to sell that stock. Your contractual obligation to sell the stock is “covered” by the stock you already own. 

And that’s exactly what we did in Real Income Trader. We bought Oasis at $14, it rallied, and we sold call options that meant we agreed to sell the stock at $17. We were paid $1.30 to sell those shares for a $3-per-share profit.

Sound like a pretty good deal? Yeah, it is. And it gets better…

We didn’t end up selling our Oasis shares. But we kept the $1.30 from the call option sale. And when Oasis rallied again, we sold another call option to sell our shares at $18. This time, we were paid $1.05 a share just for agreeing to sell the stock we bought at $14 for $18.

Just two weeks ago, we sold yet another call option on our Oasis shares. This time, we were paid $0.65 a share for agreeing to sell our Oasis stock at $19.

So far, we’ve been paid $3 a share in cash since February. The stock has run from $14 to $17. Add that $3 of stock price gains to the $3 in cash we’ve been paid, and we’re up $6 on a stock we bought for $14!

That’s how you get paid to wait. And frankly, I don’t think my Real Income Trader subscribers care if the stock rallies tomorrow or next week — not as long as we’re getting paid so well to own it.

Covered calls are a safe and easy way to get paid to own stock. In fact, the strategy is so low-risk that it’s approved for IRA retirement accounts.

If you want to learn more about this easy strategy that puts cash payments into your brokerage account, just click here.

Until next time,

Until next time,

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Briton Ryle

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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.

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