What Do Middle East Tensions Mean for Energy Stocks?
We've all read the headlines coming out of the Gaza Strip. But what does it mean for the energy trade?
On Thursday, we saw an options trader make a big bet that energy stocks will head higher. Let's look to the action in the SPDR Energy Select Sector ETF.
In the XLE, the biggest trade of the day was the sale of 29,300 XLE June 70 puts for $6.27, and the purchase of an equal number of June 66 puts for $4.45. This creates a spread known as a "bull put spread," and it is a bullish bet on the energy sector ETF.
If the XLE is above 70 at June expiration, which is 224 days away, then both options will expire worthless and the trader will get to keep the entire $1.82 collected for putting this spread on. If XLE is below 66 at expiration, then this spread will realize its maximum loss of $2.18.
The energy sector has been hit hard by the recent downturn in stocks; XLE is down 11 percent from its 2012 highs, versus a decline of 7 percent in the S&P 500 . Basically, this trader is betting that the bottom is near, and that the XLE will be higher come next June.
Rising tensions in the Middle East have created somewhat of a bid in energy stocks. (Read More: Egypt Opens Tiny Window to Gaza Conflict.)
Meanwhile, the recent downturn in the broad market has pushed options higher, on worries about the direction of the market.
Given the longer term nature of this spread, the trader appears to be taking advantage of higher option prices in light of panicked selling by others. If this conflict does not escalate, or even if it simply remains localized to Israel—which is not a major player in global energy markets—U.S. energy companies should not feel any adverse effects from a global macro slowdown.
If XLE is 1.7 percent higher than Thursday's close 7 months later, the profit on this spread will be an 85 percent return on risk. However, if XLE is 3.9 percent or more lower in June, this spread will result in a 100 percent loss.
So this trader has used this spread to basically create a binary bet on the energy sector. If you believe this sector is oversold at current levels, and is likely to rebound over the next 7 months, this spread is worth considering for a nice potential return on your money.
Brian Stutland is the President of Stutland Equities and a contributor to CNBC's "Options Action."
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