A 'Boring' Trade With Exciting Potential
Here's a way for investors to bet on a rebound in energy after the sector has underperformed in the second quarter.
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Sometimes boring is good.
This weekend I am setting up a "boring" trade utilizing The Energy Select Sector SPDR Fund ETF XLE, which gives an investor wide diversification across the energy complex.
After a solid first quarter, the energy sector has been a significant laggard so far in the second quarter. The XLE is down around 8% from where it began the quarter even as the overall market has continued to move higher.
The divergence in value is hard to ignore considering Nvidia Corp. NVDA has achieved a market capitalization that is more than $1 trillion greater than the market caps of every energy firm in the S&P 500. This includes Exxon Mobil XOM, Chevron CVX and other energy heavyweights.
Does anyone seriously believe one company will make more profits over the next five to 10 years than the entire energy sector? I am happy to take the other side of that bet.
In addition, after selling off earlier this year, crude oil has started to show some strength lately, recently hitting a seven-week high on an unexpected draw in weekly crude inventories. And there are multiple geopolitical tension points that could push energy even higher.
The Houthis in Yemen sunk a Greek cargo ship last week, using a ship drone for the first time. Some 13% of the world’s energy supplies move through the Red Sea and the cost of insurance for ship passage is skyrocketing. Many ships are being re-routed around Cape Horn, adding significantly to shipping costs and weeks to transit time. The Houthis have also threatened to expand their attacks on shipping outside of the Red Sea.
Then there is the growing possibility that Israel and Hezbollah will move to a full-scale war in Lebanon as the conflict with this Iranian proxy continues to escalate. In Europe, Ukraine is increasingly hitting Russian energy infrastructure facilities such as refineries with long-range drones and Russia is targeting Ukrainian energy/electrically generating assets in return.
Energy stocks probably also get a bit of a bid if the chances of a new administration taking the reins early in 2025 increase, which seems likely, in my view. Longer term, the industry should be a key beneficiary of the AI revolution, especially on the exploration and production side of things.
The XLE also currently yields a healthy three and one quarter percent on an annual basis. I am going to use this simple option strategy to provide a tad of downside protection while enhancing the yield from what appears to be an undervalued asset class.
Option Strategy
Here is how one can initiate a position in XLE utilizing a covered call strategy. Remember, covered call orders involve buying an equity and simultaneously selling just-out-of-the-money call strikes against the new position.
Selecting the January $90 call strikes, fashion a covered call order with a net debit in the $84.20 to $84.30 a share range (net stock price - option premium). Liquidity is excellent with the options against this equity.
This strategy provides downside protection of 8% over the trade’s duration, which includes two quarterly dividend payouts of 73 cents a share. The strategy also provides return potential of around 10%, including dividends, even if the stock trades even over its just under seven-month option duration.
At the time of publication, Jensen was long XLE.
