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Longer-Term Bet on Lower-Cost Oil


Value opportunity or money pit?

Editor's Note: We encourage discussion between our professors. In this case, Prof. Tatro had a question for Prof. Krueger about oil.

Prof. Krueger,

How would you place a longer term bet on lower oil?


Prof. Tatro,

I think it's the "disability policy" to always be pricing on a body of longs in here. If the demand falls off a cliff, the global growth story that extends all the way back into many U.S. stocks, even outside of the Energy sector, and is now working is in severe jeopardy. Therefore, like a disability policy, I think your idea is among the best to play if-you-really-need-it defense as opposed to over-insuring by taking out broad based market policies.

I've used put spreads on crude twice in the past 12 months for that type of levered protection where if I lose every penny paid in premium I'm thrilled. And I have, on both occasions. If the futures markets are out of range, then I'd look at the OIH as the most volatile way to protect against a long term fall in energy prices. However, understand that's a far from a perfect hedge because it's equipment and services, not crude, and its exposure to natural gas markets, which are behaving differently.

Again, to me, the only way to "bet," to answer your question, is to consider putting spreads where you're risking a defined amount with leveraged payoffs if correct. I simply think initiating open short positions in a secularly strong market is well beyond risk levels I'd like to take. If you prefer shorting, you'll have plenty of time to initiate positions after this sector is broken, and confirms it's broken. If you get lower oil long-term you'll want to find the wettest paper sacks to throw a rock through. At this point you'd be throwing them into a weather-tested sail with a powerful wind at its back.

Separately and perhaps longer-term, if you are correct, I'd cast an eye toward Consumer Discretionary names as longs. The perception would be that the American consumer gets a huge break and in some cases you can look at names on their backs – like casual dining – as shopping and eating become a little more difficult when you have to ride a bike. And if you price your odds correctly and demand cheap enough shares you won't even have to be right about your oil notion to have the potential to get paid.

The short answer to you question is that I wouldn't. Not yet, anyhow.

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