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XOP: A Low-Risk Entry in Oil and Gas Stocks

The bottoming process in crude oil continued last week in true topsy-turvsy fashion. Up days were followed by down days and down days by up days. Energy stocks followed suit losing a little ground on the week.

Bullish plays in the energy space continue to look attractive here so lets take a closer look at the SPDR S&P Oil & Gas Explore & Production (ETF)  (NYSEARCA:XOP ) and identify the best way to profit from its ongoing recovery.

For the uninitiated, the three most liquid ETFs in the energy sector are the aforementioned XOP, the Market Vectors Oil Services ETF (NYSEARCA:OIH ), and the Energy Select Sector SPDR (ETF)  (NYSEARCA:XLE ). Though all three have benefited from the recent crude oil recovery, XOP is the top performer.

Whats more, the XOP ETF has held up the best during this weeks chop-fest in the oil market showing relative strength versus its peers.

And the relative strength doesnt stop there.

A comparison of XOP versus the recent performance of crude oil using the United States Oil Fund LP (ETF)  (NYSEARCA:USO ) as proxy shows XOP has been handily outperforming. The following chart includes a comparative relative strength study in the lower panel that has been rising steadily since December.

While the USO has rallied 9% from its low-water mark in January, the XOP is up 23%.

Source: MachTrader

Use Options to Boost Your Probability of Profit in XOP

Because the energy sector recovery may well be a bumpy ride in the coming month I suggest using a higher probability option strategy that gives us wide profit zone. Couple that desire with the fact that the implied volatility in XOP is higher than virtually every other sector these days and bull put spreads become the obvious choice.

Sell the Apr $45/$40 put spread for 67 cents credit or better. The max gain is limited to the initial 67 cents credit and will be captured provided XOP can remain above $45. The options market is pricing in about an 80% probability of profit.

The maximum loss is limited to the distance between strikes minus the net credit, or $4.23, and will be lost if XOP falls below $40.

At the time of this writing Tyler Craig owned bullish positions on USO.

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