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Options Action

Bulls flood into oil producers, but their big bets may not pay off

Options traders bet big on an energy boost for oil

Oil producers might be about to get a big-time energy boost, if traders in the options market have it right.

The energy sector is in desperate need of some good news. It's about to lock in its status as the worst-performing sector of the decade, and the XLE ETF that tracks the space has risen only 3% since Jan. 1, 2010, while the S&P 500 has surged nearly 200% during that same period of time.

But while this decade can be chalked up as a loss for energy stocks, options traders are betting big on a rebound in 2020.

"People are buying options, they're buying call options," BlueLine Capital President Bill Baruch said Thursday on "Fast Money." "In particular, we're looking at the XOP, this is an ETF here in oil and gas production, and this 22-call strike for January expiration has seen 66,000 contracts trade today."

As Baruch would point out, those contracts traded at nearly 30 times their average daily volume on Thursday at an average of 38 cents per contract. Buyers of those contracts are betting on a move in the XOP of at least 9% to the upside by January expiration, but Baruch isn't convinced this bet will work out.

"[From the] high last October, we've seen XOP lose 50% into this month," said Baruch. "This trend line also brings some resistance at $22, which happens to be that strike price, and then you also have the 50-day moving average there as well.

"So, we have a lot of resistance up there that this market has to chew through in order for those calls to be productive."

A 50% drop from its October 2018 highs isn't the only thing the XOP is contending with. The ETF hit a new all-time low Tuesday. So, in order to capitalize on what he views as a bearish setup amid bullish options activity, Baruch looked into a risk reversal spread.

"I'm going to sell the 22-calls, it's a 22/24 call spread to limit my risk. I'm going to receive 30 cents on that, I'm going to turn around and use that money to go ahead and buy this 19/17 dollar put spread," said Baruch. "I'm looking for this thing to come in, potentially new lows in XOP, and when that happens, I want to take half that position off with a profit of 50 cents and let the rest ride."

The XOP was up more than 2% on Friday morning.