Here's the oil story. October was really something. Early November proved no better. Russian oil production has reached its highest levels since prior to fall of the Soviet Union. U.S. production hit 11.6 million barrels per day last week, a new record. OPEC, the Saudis in particular, have been pouring it on as well. The result? Not too hard to figure out, at least not in hindsight.
With inventories seemingly in a constant state of growth, WTI Crude entered into a bear market all of its own, despite Iran being put back in the penalty box. Never mind that eight jurisdictions that included both of Iran's best customers (China and India) were granted temporary exemptions from these sanction.
Leading oil producers met over the weekend. The topic that will now allow for short-term manipulation of market prices for oil is that OPEC, basically led by the Saudis, might consider lopping about a million barrels worth of daily production off of the top when they meet formally next month.
The catch is this. Russia is not technically part of the cartel. The Russian economy is still heavily dependent upon oil in order to balance the budget, and according to the Wall Street Journal, Russia only needs $53 a barrel to balance the budget -- and that break-even point is only headed lower. Russia may not play ball, or may try to extract some kind of concession in order to do so.
In the meantime, what to do with energy stocks. Nothing has really worked all that well. I maintain long positions across the space, as this group is a key component of my dividend book. These names are not really hurting me, but are almost all back near net basis. One name that has hurt me is Schlumberger (SLB) - Get Report . That position is now about as small as I am willing to take it, after being forced to reduce once my $55 panic point was breached in mid-October.
My primitive thought process on the energy space is that you do need exposure as long as the dividends are safe. I believe for the major players, as the producers increasingly make use of newer technologies in order to drive down break-even points, that oil services will halt their slide. I have been wrong on oil services in the past, so follow along only cognizant of that fact and with a personal sense of caution. Now, refiners may have also bottomed (just an opinion). With the spread between Brent and WTI reaching obscene levels, a trader might expect increased demand for the cheap stuff, and an inherently larger vig to be created somewhere in the middle.
If you follow regularly, then you know that we have been out of Valero (VLO) - Get Report for some time. The name reported a solid quarter. Cash on hand has been in decline, while total debt has been expanding. I want you to be aware of that. The balance sheet is neither a fortress nor overtly alarming, in my opinion. Other fundamental signals are benign in nature. Cash flows are solid, the short position is not significant enough to artificially impact market pricing. The name runs with a healthy current ratio. The quick ratio is slightly below what I like to see, but this is an oil company. Inventory levels must be maintained.
There are red flags here, so proceed slowly. While some see a double bottom as a positive, others will look at this chart and see an inverted cup and handle pattern. That's bearish, and considering where the stock has come from, would imply much lower prices. Yes, this is a risky sport. Just to add a little more negative pressure from a technical view, Money Flow is awful and the shares stand at the precipice of a much feared "Death Cross." So, why go there, Sarge? Why bother?
For one, my opinion over multiple decades is that news events always trump technical analysis. Always. Obviously, the energy story is at one of those points where the fundamental story could be about to change. I'm not going to risk the rent money here. I am going to lead in with maybe one-eighth of my intended position size. Why, gang? Discipline, right? Never all in or all out at one time. If I'm wrong, Valero (VLO) - Get Report pays shareholders 3.6% just to own the shares. Not bad at all.
--Target Price : $102
--Panic Point: $81
--Wall Street Average Target: $131 (according to TipRanks)
For the kid, this will be a trade, unless the stock hits $81 before $102. Then this will become an investment.
Sarge's Plan (minimal lots)
--Purchase 100 shares of VLO (last: $87.58)
--Sell one January VLO $81 put (last $2.32)
--Sell one January VLO $100 call (last $0.95)
Notes: The debit created from the two options sales drives net basis down to $84.31. The firm will pay a quarterly dividend of $0.80 on December 12 to shareholder of record on November 20. This takes net basis down further, to $83.51.
Outcomes: If the trader does get called away at $100 ahead of the next earnings release, we are talking about a 19.7% profit in 10 weeks. Conversely, if this trader is forced to double down at $81, then once the same debit for the options sales and the dividend payment for the first 100 shares is accounted for, this trader will be long 200 shares at a net basis of $82.26. The trader, at that point, would sell two out-of-the-money calls going into earning two weeks later in order to manipulate that basis even lower, while re-evaluating targets.
(A longer version of this column appeared at 7:43 a.m. ET on Real Money, our premium site for active traders. Click here to get great columns like this from Stephen "Sarge" Guilfoyle, Jim Cramer and other experts throughout the market day.)
At the time of publication, Stephen Guilfoyle was Long SLB equity.