The Rude Awakening
Wall Street, New York
Friday, July 7, 2006 ------------------------- - Drilling for profit opportunities in a slippery oil
market, - What do the options pros have to say about it all?
- Gold grabs another few bucks, the rest of the week's
data and more...
------------------------- The Pause That Distresses
By Eric J. Fry "Oil stocks are cheap," the Rude Awakening column of June
20th observed. Oil stocks are less cheap now. The XOI Index
of oil and gas stocks has rocketed 15% since that column
appeared. In response to this dazzling rally, long-term investors in
oil stocks should probably pat themselves on the back and
take a long nap. But short-term traders might want to
consider a different course of action. "Oil prices may be nearing a short-term top," warns Jay
Shartsis, a seasoned options pro with R.F. Lafferty in New
York. "The rising oil price is drawing traders back to the
long side of the crude market. The current 21-day dollar-
weighted put/call ratio for crude futures is at about 30
cents traded in puts for every $1.00 in calls. This is a
lot of optimism." In other words, even though crude touched a new all-time
high during this morning's session, futures traders are
showing very little interest in buying put options on crude
oil. Such high levels of complacency – and greed – often
presage a selloff. To put the current option readings in perspective, Shartsis
notes that crude traders last December were trading $1.75
in puts for every $1.00 in calls – or six times more than
current levels. (Not surprisingly, a sharp rally in crude
followed December's extreme bearish option readings.) But futures traders have not cornered the market for
excessive optimism. Oil stock investors are also displaying
high levels of greed...and low levels of fear. "I'm seeing a high level of call option buying in names
like Apache (NYSE: APA), Transocean (NYSE: RIG) and
Schlumberger (NYSE: SLB)," Shartsis notes. "The call buying
for SLB is the most in about two years and suggests that
this could be a good time to sell the stock." But please remember, dear investor, Shartsis is an options
trader, who operates on a very truncated time horizon. He
measures investment success – or failure – in days and
weeks, not months and years. Long-term investors,
therefore, should probably ignore the short-term sentiments
swings that Shartsis identifies so expertly. What's more, long-term investors should probably continue
to bear in mind what we pointed out in the Rude column of
June 20th: "Large cap oil stocks seem downright cheap – both in
relation to the prices of crude oil and gasoline, and in
relation to the rest of the stock market. For example, the
S&P Supercomposite Integrated Oil and Gas Index (which
trades on Bloomberg under the symbol: S15IOIL Index) trades
for a mere eight times annual earnings – or less than half
the PE ratio of the S&P 500. "Eight times earnings would seem like a much more
reasonable valuation if the price of crude oil were $39 a
barrel instead of $69. But it isn't. Energy prices remain
close to their all-time highs, which is why the earnings at
most major oil companies have been growing more than 50%
year-over-year. And yet, oil stocks attract about as much
interest as day-old French fries. Long-term investors
should probably seize this opportunity to express an
interest...by buying an oil stock or two." Thanks to the recent rally, the S&P Supercomposite
Integrated Oil and Gas Index now trades for about 10 times
estimated earnings. But the recent rally has also boosted
the price of crude from $69 to $75 a barrel. If the oil
price were to hold these levels, therefore, the actual
earnings at most oil companies would easily exceed the
current estimates. Net-net, trade around the oil stocks in your portfolio if
you wish, but don't be too eager to trade out of them
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-------------------------
Did You Notice? Fear Dissipates
By Jay Shartsis Oil stocks have not been rallying in isolation over the
last few weeks. All the major U.S. stock market indices
have been gaining ground. Not surprisingly, therefore, a
bit of excess optimism is also rearing its head in the non-
oil portions of the stock market. The July 575 put option on the S&P 100 (OEX) is $1.90 bid,
and its counterpart, the July 595 call, is $1.05 bid. In
other words, put prices are less than two times the price
of an equivalent call. This 2-to-1 ratio is a big change
from the relationship that existed last month, when puts
were trading for 10 times the value of an equivalent call. The S&P 100 (OEX) is at 585.12, right on the strike, a good
time to look at the "mirror-image" option pricing. The July
575 put is $1.90 bid, and its counterpart, the July 595
call, is $1.05 bid. At less than 2 to 1, put to call, this is a big change from
the more than 10 to 1 relationship that existed (it
actually hit 20 to 1 on one day) when the market was
bottoming last month. Clearly, the sensations of fear that
had become so prevalent during last month's sharp selloff
have given way to a comfortable complacency. The current
relationship between OEX puts and calls shows little fear
and, taken alone, suggests limited upside in store for the
market. ---------------------------
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