Bullish Outlook

The Divergence in Oil and Oil Stocks

Patrick Ceresna
August 8, 2016
4 minutes read
The Divergence in Oil and Oil Stocks

Something weird is happening in the energy markets… Oil and gas stocks seemed to stop caring what oil is doing. The divergences are staggering. What do I mean? Back in May, when crude oil was at its $50+ peak level, there was jubilee amongst investors. It has become consensus that oil has not only bottomed but is discovering a new range in the $45-$60 range to bring stability back into the battered energy markets.

How did investors react? They bought up the senior energy companies like it was the buying opportunity of a life time. With no bias, I will utilize the shares of Canadian Natural Resources TSX:CNQ (Referenced as CNQ). I can assure you that investors who did buy CNQ at $22.00 a share are feeling good about themselves, but I have to ask, does that make it safe buying new positions at $40.00 a share today?

Naively, I am going to make a basic observation as to what price levels CNQ traded at as compared to crude prices.

Maybe I am missing something, but I just cannot bring myself to justify paying $40.00 a share for CNQ, when it represents the same price that the stock traded when crude oil traded 50-100% higher than it is today.

What could some of the factors be driving the divergence?

1. Lack of alterative value sectors – Back in January 2016, many of the senior oil companies were trading at levels not seen in decades, discounting some extremely bearish outlier scenarios. This drove value investors, and later momentum and technical traders to follow.

2. Search for yield – With bond yields collapsing to historic lows, income investors have been starved for yield. Once it became clear that many senior oil companies were not going to cut their dividends (at least not initially), investors could not help themselves trying to catch a potential bottom.

3. Index weighting – The Canadian S&P/TSX60 is 20.38% weighted into energy (July 29,2016). After the January 2016 lows, domestic and international investors were buying the Canadian market broadly looking to participate in a potential bottom in the resource markets. This broad index buying weighs money into energy irrespective of current macro fundamentals.

What has this created? A market where oil stocks are trading at price/earnings multiples that are normally reserved for high growth tech companies. Observe the chart below.


So what could an investor do beyond outright selling everything? Hedge!

After such a strong run higher, any investor that has bought an energy company over the last 6 months is likely profitable or close to it. This is when buying a protective put with some of the profits may be a solid alternative to selling. The buying of the put option ensures that you locked in a guaranteed sale price, allows you to continue to collect the dividends and prevents you from incurring a tax disposition in the sale of the stock.

When you own a put option, it gives you the control in the decision to exercise the right to sell. Alternatively, if profitable on the put option, the investor can simply monetize the profit. At minimum, for investors that are new to options, it is worth knowing all the alternative investment choices beyond just the traditional buy/sell trading decision.

Patrick Ceresna
Patrick Ceresna http://www.bigpicturetrading.com

Derivatives Market Specialist

Big Picture Trading Inc.

Patrick Ceresna is the founder and Chief Derivative Market Strategist at Big Picture Trading and the co-host of both the MacroVoices and the Market Huddle podcasts. Patrick is a Chartered Market Technician, Derivative Market Specialist and Canadian Investment Manager by designation. In addition to his role at Big Picture Trading, Patrick is an instructor on derivatives for the TMX Montreal Exchange, educating investors and investment professionals across Canada about the many valuable uses of options in their investment portfolios.. Patrick specializes in analyzing the global macro market conditions and translating them into actionable investment and trading opportunities. With his specialization in technical analysis, he bridges important macro themes to produce actionable trade ideas. With his expertise in options trading, he seeks to create asymmetric opportunities that leverage returns, while managing/defining risk and or generating consistent enhanced income. Patrick has designed and actively teaches Big Picture Trading's Technical, Options, Trading and Macro Masters Programs while providing the content for the members in regards to daily live market analytic webinars, alert services and model portfolios.

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