How to trade rising natural gas prices and falling oil prices

Part 6
How to trade rising natural gas prices and falling oil prices (Part 6 of 6)

Getting oil exposure through individual names and equity ETFs

Upstream energy names focused on crude oil production also provide exposure to oil prices

Investing in individual upstream energy stocks with significant crude oil production and assets also provides exposure to crude oil prices. The following list shows select stocks with majority crude oil production during 3Q13.

 

% of 3Q13 Production from Crude Oil
Oasis Petroleum 92%
Continental Resources 70%
Hess Corp. 70%
Chevron Corp. 68%
Concho Resources 60%
ExxonMobil 52%

Note that while the correlation in performance between these oil-weighted stocks and crude oil prices is significant, investing in these companies also means exposure to other risk factors besides oil.

2014.01.16 - correlation crude vs crude companiesEnlarge Graph

For example, these companies also have natural gas production, so investing in them also provides some natural gas exposure. Plus, there’s always the factor of company-specific risk. For instance, investing in BP right before the Deepwater Horizon incident would have been a losing bet, regardless of the direction of crude and natural gas prices.

To potentially profit from a drop in crude oil prices, it’s possible to short these individual names, sell call options, or buy put options on the names. Note, however, that shorting stocks and selling calls can be extremely risky, as there’s no theoretical limit to losses (there’s no limit to how high a stock can go). Buying put options means losses are limited to the cost of the option. However, investors should also be aware that options are also bets on stock prices’ volatility.

Broad energy equity ETFs also correlate to oil prices

ETFs such as the Energy Select Sector SPDR (XLE) are highly exposed to movements in crude oil prices, as they show significant correlation to crude price movements.

2014.01.16 - correlation crude vs etfsEnlarge Graph

To short these ETFs would also be an implicit bearish bet on crude oil prices. However, note again that these ETFs can also be highly exposed to other factors, such as the general direction of the market, the direction of natural gas prices, and drivers such as sector rotation (the market shifting funds from one sector, such as energy, to another, such as consumer goods). Again, note that shorting securities can carry significant risk.

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