Oil Bears: Smart Money, or Contrarian Signal?

What heavy put volume on the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) means for contrarians

by Adam Warner

Published on Oct 31, 2014 at 8:53 AM
Updated on Jun 24, 2020 at 10:16 AM

Even though the market has recovered most of its gains, oil really has not. The rolling crude near-ish future (now December) peaked at $107.68 in late June, and then dropped to just under $80 by mid-October. It bottomed at $79.44 on Monday, and is still hovering near $80.

And, all that punk action has of course transferred into stocks in the industry, and lately has sparked a flood of put trading. This, via Bloomberg:

Even after valuations for an index tracking the shares slumped 40 percent, investors are loading up on bearish options. The cost of puts on the SPDR S&P Oil & Gas Exploration & Production ETF jumped to the the [sic] highest level in seven years versus calls. The exchange-traded fund tracks companies including Exxon Mobil Corp., Chevron Corp. and ConocoPhillips, which are down more than 9 percent from their highs this year.

… Companies in the index that the oil ETF (XOP) tracks trade at 26.6 times reported earnings, data compiled by Bloomberg show. Multiples fell as much as 39 percent from June to a one-year low on Oct. 14. The benchmark Standard & Poor's 500 Index has a valuation of 17.6 times.

Both volume and the number of options outstanding on the oil ETF surged this month, and nine out of the 10 most-owned contracts are bearish. Those hedging against a 10 percent decline in the fund cost 10.7 points more than calls betting on a 10 percent gain on Oct. 28, according to three-month implied-volatility data compiled by Bloomberg. That's the widest spread since September 2007.

On the surface, it sounds bullish, from a contrarian basis. It's an old saying that you want to get greedy when others are fearful, and there sure is plenty of fear around.

Implied volatility in the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) did make quite the move, as well. The XOP "VIX" was as low as 21 in late August, then peaked as high as 58 in mid-October. Then again, that's pretty much in line with the percentage move in the actual CBOE Volatility Index (VIX). Unlike the actual VIX, though, XOP volatility has only dropped back to the low 40s.

One warning, though: Be careful deriving too much signal when options are telling you the same story as the stocks themselves. If we saw all this put interest while the energy patch was booming, it would tell me that no one believes in the boom, and the public at large is trying to catch a top. That rarely works in the aggregate. But, a spike in put interest in a weak group? That makes some sense.

Now, don't get me wrong: I'm not saying that action is bearish. It's not likely "sharps" are loading up on puts now. It's just that it's a weak bullish signal.

It is interesting that XOP has recovered better than crude itself. It bottomed at $52.15 in mid-October, about when crude was first hitting lows. It has since popped to the mid-$59s. So, maybe the masses already have backed up the volatility truck at the bottom? If nothing else, it's a level to lean against.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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