Two Ways to Play an Oil Bounce

We have discussed how the market has become highly correlated to oil prices -- the price of crude has reverted to being the simplest and most direct form of an economic indicator. With oil prices having corrected about 66% from peak to the recent low, we have seen selling in this commodity for every reason possible. It's true that oil prices may have been too high during the rally -- bid up by speculators, especially near the end of its rally as prices went parabolic -- but demand had been driving prices to the $100 mark before speculators entered the market in earnest.

If we continue to believe that oil demand is on balance increasing due to emerging-market demand, and that supply is limited and actually on the decline -- the old peak-oil theory -- then it raises the question: Should we be viewing this pullback as a longer-term opportunity? It would seem the answer is yes.

Now, before we continue, let's also consider the risk to this theory in the near term. The economic slowdown may continue to deepen and may last longer than we anticipate. If this is the case, we expect oil demand will remain subdued and prices to remain low. As far as traditional oil companies and service companies, they still have money in the ground or are providing equipment to drillers and explores. The commodity remains extremely valuable and will most likely see a resurgence of demand an interest as the recession weakens and ends.

Assuming you follow the theory, this pullback is an opportunity to do some buying. For now, the space has become very homogeneous, and while we may be able to debate from a fundamental standpoint one company over another, we are simply concerned with having exposure to the sector. This is best done through one of the ETFs that track oil stocks.

Energy Select Sector SPDR (XLE)

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With the recent volatility, we will use the Energy Select Sector SPDR (XLE - commentary - Cramer's Take) for our trading vehicle. There are two ways to view this. First, there is the short-term trading opportunity based on last week's test of the low in this ETF and positive divergences that occurred during that test. The selling was much less intense during the recent decline, and that sets up a situation where any buying should have a more positive impact. Near term we see the XLE trading up toward $55 or $56. A stop is very clear in this trade -- we would put that at a new closing low below $38.

Longer term, there is an opportunity as well. This will take some patience, but assuming our theory about demand is correct, we're in a good spot after an almost 70% decline to establish some exposure for a longer-term investment. This trade carries with it a higher risk, as the stop level would be more in the $36 area.

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Know what you own: Hughes and Maragioglio mention the Energy Select Sector SPDR. Companies in the ETF include ExxonMobil (XOM - commentary - Cramer's Take), ConocoPhillips (COP - commentary - Cramer's Take), Chevron (CVX - commentary - Cramer's Take), Schlumberger (SLB - commentary - Cramer's Take), Occidental Petroleum (OXY - commentary - Cramer's Take) and Devon (DVN - commentary - Cramer's Take).

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At the time of publication, John Hughes and Scott Maragioglio had no positions in the stocks mentioned.

Hughes and Maragioglio co-founded Epiphany Equity Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indices and sectors. Hughes advises numerous asset managers, hedge funds and institutions managing in excess of $30 billion. Maragioglio is a member of the market technicians association (MTA) as well as The American Association of Professional Technical Analysts (AAPTA) and holds a Chartered Market Technician (CMT) designation. Maragioglio has also served on the board of directors of the AAPTA.