Recently, there’s been a lot of talk about oil. Those of you in our mentor club know that I’ve been building a position in oil investment over the last six months. This past week presented some changes that have caused me to adjust my position. I’ve decided to go short for the short-term, and I want to explain why.
Oil Trends and Shifting My Position
Oil was rather high in June and July of 2014, but it plummeted last December. That’s when I began to get really interested in oil. At that point, I wasn’t quite sure what the future held for oil prices, but I recognized the dropping prices and suspected that it would likely hit a bottom because it had dropped so far from the top at the end of last June.
As I noticed this trend, I decided to use the strategy of selling puts on the low end in December. It’s a clever strategy that Warren Buffet uses. Think of selling puts as promising to buy the stock at a certain price. Generally, if the price goes down we’re going to be able to acquire, and if it goes up we keep the premium.
I continued to build my position through selling puts up until June of this year when I was satisfied with the amount of shares I was able to build. Even though the oil trends didn’t rise significantly, I remained profitable because I was getting income through selling along the way. In short, I was getting paid to buy the stock at cheap prices.
In the last couple of weeks, I’ve been concerned about my position. On March 18th of this year, we established a support level when the market was low. In a normal stock, we could see that the low would be a level of support. However, when you look at the actual crude oil itself, we could see that it hasn’t actually come down to its lows. My feeling is that the recent downward turn is likely going to either test or break the support. As a result, I decided to shift to a bearish posture, meaning that I sold the shares I was getting paid to acquire.
Oil vs. Other Stock
The difference between oil and stock is that a stock can cause you to go bankrupt. A stock can drop all the way to zero, but I don’t see oil doing that. It would be insane to believe that oil could someday be free: it’s a major commodity and it costs money to extract from the ground. As a result, I think there’s a major support level coming up pretty quick here. Even if it breaks that support level, I’m okay with that.
If you go back into history, you can find major lows in oil prices. In the 90’s, for example, the price dropped to $10 for oil. I doubt it will drop that low these days because I believe that there is more global demand for oil today than there was 20 years ago and the technology to extract it is likely more costly.
Making Educated Decisions
Between 2008 and 2009, the price of oil plummeted dramatically, but then it found support and was brought back up. I believe it might follow that trend again. I think the lower the cost goes, the better it is to buy because it is rather unlikely that oil will hit the zero mark. So the lower it gets, the more excited I get about it. I’m going to go for the short-term, and them I’m going to keep buying puts to return to my original position of going long in the long-term.
I’m not much into the financial advice thing, but I’m into the education thing. I hope you don’t take this lesson as “Andy’s prediction about oil.” I could be totally wrong – I’ve been wrong before! More importantly is how I’m making investment decision.
I hope this lesson has caused you to ask yourself a few questions: Do I know how to sell puts? Do I know to sell calls if I want to manage risk? Do I know how to buy puts if I want to go bearish? What do I know about protective puts? Do I know how to neutralize my position with synthetic shorts against my long position? Do I understand all the jargon that goes into it? Those are big questions that I think people should ask. Check out my Four Pillars of Investing to bolster you financial education and learn how to be powerfully in control of your money.
If you’d like to continue to follow us each week with our oil investments, join us in the the mentor club!