Consumer Skepticism

A number of the big name oil companies are reporting earnings this week and many analysts think that the numbers may be worse than expected, which is to say worse than numbers that have already been revised downward.

Still, this is one case where you might want to take the numbers with a grain of salt. Let’s face it, tighter margins and lower earnings will reflect what everyone already knows. Despite one day surges like we saw last week, oil is unlikely to move substantially beyond its current US $40 to US $60 trading range for the remainder of 2015.

In my mind, the real story is how consumers have shrugged off lower oil prices. In my last column, I posited that North American consumers may have caught the savings habit and while that is one explanation, there is another possibility. It may be that consumers’ predilection to save has more to do with disbelief than a desire to strengthen their balance sheets. In other words, consumers are reluctant to accept that oil prices will remain at these depressed levels.

The longer oil remains within its current trading range, the more likely consumers will suspend their skepticism. That could lead to a surge in consumer spending in the second or third quarter of 2015, which would go a long way towards providing the kind of oomph that the economy needs. And by the way, be positive for North American equities.

Another consideration that should be factored into this mix is the Bank of Canada’s (BOC) recent interest rate cut. Clearly the BOC is comfortable with a low Canadian dollar, which, in the long run, keeps our exports competitive at a time when the rest of the world – the Eurozone, Japan and China – is engaging in all out currency wars.

What we have then is a triple threat;

1) consumer skepticism

2) low interest rates

3) a weak loonie

A couple of companies that can benefit as the threats dissipate are Canadian National Railway (Symbol: CNR, Friday’s close $83.72) and Canadian Pacific (CP, $221.81).

If this is a second half story, speculative traders might look at buying calls on these companies. The CNR September $84 calls at $6.10 (implied volatility 22%) and the CP July $220 calls at $19.10 (implied volatility 27%) look interesting.

You could also consider bull put spreads as the calls may be a bit too pricy for some traders. With CNR, you could sell the September $84 puts at $6.50, while buying the September $76 puts for $3.30. This spread generates a net credit of $3.20, which is if the stock closes above $84 in September causing it to expire worthless. The maximum risk will occur if the shares close below $76 in September. In that case, you would be required to buy shares of CNR at $84, but would have the right to sell the shares at $76. The maximum risk is the difference in strike prices, $8.00, less the net $3.30 credit received or $4.70 per share.

With CP, you could sell the July $220 puts at $16.25 and buy the July $200 puts at $8.75. Assuming you can get these prices, the spread generates a net credit of $7.50. If CPP closes above $220 in July, both options will expire worthless and you will retain the net credit. The maximum risk occurs if the shares close below $200 in July. In that case, you would be required to close out the position at a price of $20 per share, which would be a loss of $11.25.