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What options strategies are best suited for investing in the utilities sector?

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posted Jul 14 by Chetan Hindu

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The oil and gas drilling sector offers many advantages to an investor. Because increases in oil and gas prices often go hand in hand with a slow economy, investments in this sector can serve as a great hedge against falling stock prices in other areas of your portfolio. Companies in the energy sector tend to do well when the price of oil is high. The profit potential in the oil and gas drilling sector is enormous. A productive well brings in many times more revenue than what it costs to operate, and investors who own shares in a company that drills on such a well receive huge returns. The downside of investing in oil and gas is the potential for extreme volatility. For example, during the five-year period from 2008 to 2013, oil prices went as high as $148 per barrel and as low as $32 per barrel.

The right options strategies can help you take advantage of the benefits of oil and gas investing and also mitigate risks due to volatility. One such strategy is the long straddle, where you purchase a call option and a put option with the same strike price and the same expiry. This strategy is great for a volatile market because you have a winning bet no matter which way the market moves. If it makes a big move upward, you can exercise the call option for a nice gain; all you lose on the put is the price you paid for the option. If the market drops, you can exercise the put. Interestingly, the biggest risk with the long straddle strategy is a sideways market. If the market does not move much in either direction before the expiry, the options fizzle out and you lose the money you paid for them; this strategy is best employed during periods of volatility and with historically volatile markets such as oil and gas drilling.

A similar options strategy preferred by many oil and gas investors is the long strangle, which is similar to the long straddle, except the call option and put option have different prices. With the long strangle, you purchase a call option with a strike price higher than the current price of the stock and a put option with a strike price lower than the current price of the stock. Both of these options are termed "out of the money" because they have no intrinsic value; they only become valuable when the stock price crosses the strike price in either direction. Therefore, they are much less expensive than long straddle options, known as "at the money" because both the call and put option strike prices equal the price of the stock. With the long strangle, you profit if the stock goes up past the call option strike price or down past the put option strike price. Although you lose if the stock stays between the two strike prices, your losses are limited to the option costs, which are low with this strategy.

answer Jul 15 by Sherlyn Mishra
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