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Tanks and Oil

Richard Croft
January 30, 2011
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The deteriorating political situation in Egypt has presented some interesting possibilities for options traders in the oil and gas sector. The civil strife in Egypt has led to concerns that the Suez Canal might be temporarily shut down, blocking transit of oil supplies through this vital channel. That, of course, raised the price of crude oil to around US$89 per barrel and had a knock-on effect on the share prices of Canada’s oil majors, resulting in a 1.5% advance in the S&P/TSX Capped Energy Index for the week.

The jump in crude oil and last week’s price spike in Canadian energy majors like Suncor Energy Inc. (TSX: SU, $40.04) and Canadian Natural Resources Ltd. (TSX: CNQ, $43.08) are unlikely to become permanent. While the Egyptian situation is volatile, it is unlikely to deteriorate into another Tunisia, Sudan, or Lebanon, although undoubtedly Iran and its agents in Egypt are busily stirring the pot in an attempt to make it so. President Movaric has already lost power. The question is whether he leaves office voluntarily or by force.

If this movie plays out as expected, this might be an opportune time for option traders to take a bearish stance on Canadian energy stocks. This is not a bet that energy will collapse, but rather a bet that the rally is overdone. If the Suez Canal is unaffected, and if / when conditions normalize in Egypt, energy prices and Canadian energy stocks will gravitate to more normal valuations. Most likely lower than current levels.

The optimum strategy is to limit risk through the purchase of puts. The cost is reasonable because volatility has narrowed, making option premiums relatively cheap. And put buying limits the risk of the trade to the cost of the puts.

With Suncor, look at buying the SU March 40 put at $1.30. With Canadian Natural Resources, look at the CNQ Mar 42 puts at $1.45.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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