A Long/Short Strategy in the Energy Sector

The long/short strategy is a device commonly used by Wall Street fund managers and professional traders to hedge risk, minimize fund allocations, and profit from outperformance rather than simple capital appreciation.
That last point is key. Why? Because if you decide to purchase ABC stock and it drops, you’ve lost both money and time. Your bet has just a fifty-fifty chance of proving itself, and even if you trade with stops, the odds are less favorable than if you trade two securities against each other.

Winning in Two Directions

Long/short traders select the best and worst stocks in a sector or asset class and trade the stronger one long, the weaker one short. Once the trade is put on, the market can move higher or lower; it doesn’t matter. So long as the “strong” stock moves up faster or down slower, the trade wins.
Let’s have a look at three securities charted against one another to get a better feel for the initiative.
The first is oil, represented by the United States Oil Fund (NYSEArca: USO), a proxy for Nymex crude. The second is the Energy Select Sector SPDR ETF (NYSEArca: XLE), a proxy for the oil and gas sector at large. And the last is a company called Tesoro Corp. (NYSE: TSO), a successful midsize refiner and marketer.

The price of oil topped out in June 2014 (far left of chart) and since then has lost nearly 80% of its value (USO, in blue). The oil and gas sector (XLE) has fallen by nearly 50% over that time frame. But shares of Tesoro have gained a whopping 55%.
How can it be?
The reasons for such a stellar outperformance are numerous, but because we’re limited in space, I’ll offer just one.
Well managed and fiscally disciplined refiners like Tesoro will make considerably greater profits than exploration and development companies when the price of oil is falling quickly. The reason for this phenomenon is the considerable lag time between falling crude prices on one hand, and the much slower declining price of refined products like gasoline, diesel and jet fuel that companies like Tesoro process.
It’s that widening gap for the last year and a half that Tesoro has exploited beautifully. The company should continue to profit from that gap now that Iranian oil is coming onstream, further pressuring the price of crude globally. Margins for companies like Tesoro should only improve going forward.

The Trade

With that understanding, I’m going to bet on Tesoro continuing to outperform its peers in the energy sector. So I suggest going long Tesoro and short the Vanguard Energy ETF (NYSEArca: VDE). I’ve suggested the VDE fund instead of XLE simply because it trades for a higher price – the better to offset the cost of the Tesoro purchase. As for performance, VDE and XLE are virtually identical.
Suggested Action: Buy TSO at the market (recent price was $90.73) and short sell an equal number of VDE shares at the market (recent price was $76.62) for a total debit of $1,411 per board lot traded.

You won’t find this anywhere else

You’ll never read about this powerful trading strategy in The Wall Street Journal. Or see it discussed on CNBC. 99 out of 100 brokers know nothing about it. Yet this nearly risk-free trading system has been able to turn $330 into $3,300. And it’s been put together by one man who wants to share its secrets with you. Discover them right here.