Is it Time to Pocket Profits on Energy Stocks?
One of my readers posed this question last week: “Are we perhaps seeing a topping off in the energy sector, calling for a reduction in the allocation to the sector (i.e., take profits on at least some percentage of the allocation to the energy sector)?” In other words, is it time to take the money and run?
He noted that we used the word “energy” 54 times in our May 2022 issue of Personal Finance, up from 34 times in May 2020. Over the same span, the iShares U.S. Energy ETF (IYE) has nearly tripled in price.
There is plenty of anecdotal evidence to suggest that the energy sector is close to topping off. Oil prices surged in March after Russia invaded Ukraine on February 24.
As recently as early December, the price of a barrel of oil was less than $70. Three months later, it briefly spiked above $130. Even though it has since fallen back below $110, by historical standards the price of oil is still quite high.
As long as crude oil prices remain this high, oil producers should be very profitable. Already, consumers are complaining about high gasoline prices to the point that accusations of price gouging and profiteering are being made by government officials.
The White House is reluctantly considering taking actions that would temporarily push down gasoline prices by increasing the supply of crude oil. This may be the only time the Biden administration will find enthusiastic agreement on the other side of the aisle in Congress.
Summer Driving Season
The argument for energy stocks going even higher is based on the belief that oil prices can remain above $100 a barrel for a long time. The economic sanctions imposed on Russia by most developed nations won’t go away as soon as the war is over.
Also, the so-called “summer driving season” is rapidly approaching. Last year, Americans consumed 12.4% more gasoline from May through August than they did during the first four months of the year.
For both of those reasons, I don’t expect energy stocks to crash anytime soon.
But sooner or later, perhaps as soon as this fall, the imbalance in supply and demand for gasoline will moderate. As the old saying goes, the cure for high oil prices is high oil prices.
Eventually, oil producers will ramp up their drilling activities to take advantage of high crude oil prices. And by so doing, they will drive down crude oil prices by increasing the supply.
In that case, should you sell some of your energy sector holdings now to lock in current share prices? Certainly, nobody should feel guilty about selling Chevron (NYSE: CVX) now at its all-time price near $175 when it was trading below $100 last summer.
Keep the Change
However, there are other ways to cash in on the energy sector’s recent surge. For example, rather than sell your shares of Chevron, consider selling a covered call option against those shares instead.
Last week while CVX was trading near $174, the call option that expires on November 18 at the $185 strike price could be sold for $10.
If CVX never rises above $185 between now and then, this option will expire with no value. In that case, you still get to keep your shares of CVX and the $10 option premium (plus any dividends paid along the way).
If CVX rises above $185 prior to expiration then this option may be exercised against you. In that case, you must sell your shares for that price. You still get to keep the $10 option premium plus any dividends paid prior to expiration.
That means CVX would have to rise above $195 within the next seven months for this trade to be inferior to simply holding onto your shares. I don’t know how likely that is, but I’d be surprised if CVX appreciated another 11%+ this year given its recent surge.
For further expert advice on covered call strategies, consider our premium publication, Rapier’s Income Accelerator.
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