Is It Time To Short Oil?

A surprising statement came out of The White House recently suggesting that depleting the Strategic Petroleum Reserve is an option. The effect, of course, would be to put downward pressure on oil prices at a time when consumers are increasingly feeling the effects of inflation, so is it time to consider a bearish play on oil?

When we examine the chart of Crude Oil, we can see it sits at a pivotal point at this time, right at the top of a long-term downtrending resistance line.

Credit: eliant_capital

A failure to breach above that line would be a significant win for the bears but the upward forces in recent months have been powerful.

As you can see from the chart below, one of the oil sector flagship stocks, Exxon (NYSE:XOM) has been in a stark uptrend over the past few months.

The upward trajectory appears to be justified when the fundamentals are scrutinized.

Exxon has a Perfect Piotroski Score of 9, has demonstrated consistent increases in earnings per share, raised its dividends for four straight decades, trades at a low price-to-earnings ratio relative to its forecasted earnings growth, and a handful of analysts have revised their projections higher in recent months.

Among 23 analysts, the consensus price target for XOM share price is $123 per share, slightly above the current level at which the stock is trading.

A discounted cash flow forecast analysis reveals fair value to sit even higher at $132 per share, which would imply potential upside of 13.2%.

Another fundamental factor in favor of Exxon is a high return on invested capital, a key metric for any company. XOM currently has a 20.7% ROIC, which is significantly larger than the sector average of 5.1%.

Is It Time To Short Oil?

Shorting oil at this time is a risky proposition because oil prices have stayed persistently high in recent months on the back OPEC measures to control supply combined with increases in demand.

If you were to consider shorting oil, Exxon could be a good proxy, however its fundamentals have been rock solid no matter how you examine them, whether earnings, other profit multiples like ROIC, cash flows, or even analysts’ estimates.

With that said, technically oil sits perched at a very precarious level, right below a long-term downtrending resistance line. If prices fail there, the future could be ominous for the price of crude oil, and in turn Exxon which is directly tied to the price of oil.

If the play does appear compelling from a technical standpoint, consider an alternative to shorting stock, which has an accompanying borrowing fee.

Buying put options on the Energy Select Sector SPDR Fund (NYSEARCA:XLE) is another way to capitalize on lower prices without opening a porfolio up risk of a spike higher with unlimited liability, as a short play features.

Of course, there is no free lunch in the market and put options have their own drawback in the form of theta decay. If the price of oil doesn’t fall quickly, and XLE fails to follow its downward lead, the put options value will erode due to the corrosive effects of time-decay. So, a bearish play using options needs to be right not only in terms of direction but time also.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.