Active-Trader - Seasonal Low in Energy

Welcome back Active Traders and Wealth Builders.

Every once in a while a trend change comes along that's so obvious, those who miss it are just not paying attention.  And the recent turn in energy prices is one such example.  Let's examine the evidence.

To your left is a 24 year seasonality chart of crude oil.  Its seems pretty obvious that low point on the chart is right about mid to late February which is hopefully just about the time you are reading this blog post.

Now your first instinct might be that its time to load up on oil.  I'm not a futures trader and I don't find the leverage to be either necessary or useful.  In fact the opposite is the case, the leverage can shake you out on the slightest wiggle. I had the same experience with Forex and I find its better to just avoid highly leveraged vehicles.  The only exception would be options on equities which I can trade right out of my equities account and risk the same or a smaller amount that I would with a straight stock position in the underlying.

As for the best way to trade energy, let's break out TC2000 and examine a few alternatives include energy ETF's USO, DBO and energy equity ETF's XLE and OIH.  A look at those in the scan on the left show that OIH and XLE are actually positive for the year while energy commodity ETF's are actually down for the year.  More significant, look at the dividend yield of OIH and XLE to find a positive number versus the dividend yield for the actual commodity EFT's which is - zero.

This brings up the core problem with investing in actual commodities and that is called negative carry.  Put another way that means it costs money to hold crude oil and other energy assets.  This is reflected in term structure of future's contracts where farther dated contracts are usually priced higher than nearer dated contracts to reflect the cost of storing the commodity for delivery on that future date.  This term structure can erode the return of holding commodities over a period of time even when the price holds constant.  Take a look at performance of USO and you will see that it does a poor job of matching the overall return characteristics of crude oil due to the cost of carry and other costs such as maintaining a portfolio of future contracts to construct the index.

So what the answer?  Energy stocks of course.  Energy stocks have a positive carry as reflected in the dividend paid by the stocks themselves.  And you can see those results clearly in the returns above for the year as well as in the dividend yields themselves.  There are probably even smarter ways to trade energy like selling puts, or put spreads or selling calls against your positions to bring in extra income.  But I am not an expert on energy companies and until I get to know more will be happy to invest in energy ETF's OIH and XLE.

One more tip for you - bring up a chart of OIH inside Thinkorswim and select Style, Chart Mode, Seasonality.  You will see a chart that looks like the one on the right.  Notice how OIH starts the year at a low and then tops out some time between August and September.  There's your seasonal high and when its time to take profits.  And there you have it a way to play energy ETF's with a better than even chance of coming out ahead - particularly when you factor in the dividends.

So go out there and dump your USO and buy some XLE and OIH.

And have a great week ahead.