Oil Prices Are Soaring. It’s Time to Hedge or Sell.

At the top of Americans’ concerns is rising inflation, especially soaring prices for energy, filling their gasoline tanks, or paying their monthly utility bills. And investors and traders have ridden the roller-coaster rise in prices, sending futures and energy-related stocks and exchange-traded funds skyward, especially after Russia’s invasion of Ukraine.

That means it’s time to take profits in energy plays, especially for late-arriving bulls who have piled onto the panic in oil and gasoline prices. As has ever been the case in commodity markets, the cure for high prices is high prices. With oil topping $100 a barrel, one iconoclastic analyst advises traders to buy put options on soaring futures for crude and refined-product contracts, to profit on the bubble he sees bursting.

There has been a buying panic in the energy markets, says Walter Zimmermann, chief technical analyst at ICAP, the institutional interdealer futures broker, as sentiment has shifted to “fear of not having enough” from the “fear of having too much” that prevailed in 2018-2020. Before the invasion, crude oil prices had nearly doubled, with no change in market fundamentals. That is a sign of a speculative bubble, he contends.

It’s easy to finger Vladimir Putin as the culprit, but Zimmermann thinks the Federal Reserve’s quantitative easingshould shoulder a chunk of the blame. Way too much QE created “the golden age of speculative bubbles,” he says in a telephone interview. (And the Fed continues to purchase Treasury and mortgage-backed securities, easing monetary policy, while most observers are focusing on future tightening.)

Still, the market is doing its job of discounting the most extreme and unsustainable outcome of the energy run-up, he says. That sentiment has been fanned by headlines aimed to maximize mouse clicks or viewership, Zimmermann asserts, much like weather channels that tout every winter storm as a “snow-mageddon.” (To let you in on the sausage-making, media outlets are obsessed with SEO—search engine optimization—to make it easy for Google and its ilk to pick up their stories and thus maximize clicks.)

This has produced a “full-blown panic,” Zimmermann continues, with the most recent buyers being sucked in at the worst time. Bullish sentiment is at historic highs, as indicated by polling services such as Market Vane. This shows that the last buyers have bought in, he says, while the remaining shorts have been stopped out and forced to cover their positions.

(In futures markets, speculative shorts sell contracts for future delivery, expecting to buy them back at a lower price. Hedgers, such as farmers selling against their expected harvests, sell contracts against future production, with no plan to buy them back.)

But, Zimmermann warns, the oil producers he keeps tabs on say they’re ramping up drilling, based on futures prices. Even though energy markets exhibit “backwardation”—meaning that prices are lower for deferred deliveries than for near-term ones—producers are “dancing a jig” over being able to lock in profits.

While the front-month contract for April delivery settled at $107.67 a barrel Thursday, a producer could guarantee an attractive profit by selling for July delivery at $96.78. Speculators who “roll” their contracts by selling the expiring front contract to buy the next month’s at a lower price have been making money on the trade, further bolstering the bulls’ confidence about easy gains, he adds.

But once the bulls’ buying power is exhausted and the higher prices incentivize producers to boost output, Zimmermann says, the peak is near. And, in his view, the impact of the loss of Russian oil production of three million barrels a day, out of daily global demand of 96.5 million, is being exaggerated by bullish sentiment.

For traders, he recommends buying what he calls “cheap” put options, which would protect gains on long positions or profit from future declines. Most readers aren’t futures traders, but for those who have participated in the advance in energy-related stocks, he also agrees with the suggestion of selling call options against their positions to earn extra premium income.

For instance, the


Energy Select Sector SPDR

exchange-traded fund (ticker: XLE) is up over 20% since the beginning of the year and is near a 52-week high some 60% above last summer’s low. With the ETF closing Thursday at $73.12, an investor could write (that is, sell) a May call at $80—a premium of $1.90.

If the ETF doesn’t top that strike price by expiration, the seller keeps that premium, a nice supplement to the dividend yield of nearly 4%. If it does go higher, the shares will be called away by options purchaser and the seller misses out on further gains.

Looking back, the ETF has topped $80 only at the peaks of oil price spikes in 2008 and 2014. That also was before oil companies became pariahs to the ESG (environment, social, and corporate governance) movement.

Now that everybody knows oil prices are soaring, those who were early to the bull case for energy might think about cashing in some profits, or at least hedging them.

Read more up and Down Wall Street: Putin’s War Puts Russia’s Economy—and the World’s—in Its Crosshairs

Write to Randall W. Forsyth at [email protected]

Source: https://www.barrons.com/articles/oil-prices-51646408148?siteid=yhoof2&yptr=yahoo