ENERGY STOCKS AND ENERGY COMMODITIES

The relationship between energy commodities – such as Oil, Gasoline, and Natural Gas – and the stocks of energy companies can be somewhat confusing at first glance, but understanding the fundamentals at play can provide a savvy investor with the opportunity to profit off of the volatility of energy commodities by trading binary options.

The first thing to understand is that energy stocks are generally much less volatile than the energy commodities that underlie them. As a result, when commodity markets experience huge swings back and forth, little change may be seen in the corresponding options. Investors who play in energy options will tend to wait until a clear direction can be seen in the commodity market before they take a position, adopting mid-term positions rather than the short-term positions favored in the commodities market.

The other thing to recognize is that commodity options can suffer both from overly weak commodity prices and from overly strong commodity prices. Cheap Oil, for example, will generally push up the value of manufacturing-based equities, as growth increases when Oil becomes more affordable. Cheap Oil has the opposite effect on the stocks of oil developers and processors, however, since their profits are severely cut by lower prices. On the other hand, if the price of Oil passes a certain threshold, growth is impeded, reducing demand for the commodity, and resulting in growing stockpiles for those same companies, which also damages their stock value.

As a result, trading commodity options is primarily about identifying balance points between over-valued and under-valued commodities, where growth is maximized but profits remain maximized as well. One easy way to determine this for Oil is to simply look at OPEC’s target price for the commodity, as their driving motivations are much the same as private-industry energy companies. Once an investor has an idea what his target is, all that remains is to wait for prices to move toward that equilibrium and stabilize, at which point the stocks will almost certainly increase in value until equilibrium is lost.