The energy sector is the red-headed stepchild of the market – unloved and forgotten. But that’s what makes it intriguing to the contrarians and dumpster divers among us. Today we’re going to explore how to profit if energy comes back into favor in 2020.

There are many ways to illustrate just how pathetic its performance has been. My top three ETFs for tracking oil stocks are XLE, XOP, and OIH. They boast liquidity aplenty and have actively traded options, which makes it easy to build cash flow systems on them. Here are a few characteristics of each:

XLE: The slowest and safest of the bunch. It’s heavily weighted toward large caps with Exxon and Chevron comprising over 40% of the fund. Implied volatility is 19%, and it offers a large dividend yield.

XOP: This oil and gas ETF offers a widely diversified bet on some 60 small- and mid-cap stocks. Implied volatility is 32%, so it has juicier premiums than XLE. Because it focuses on smaller companies, its dividend yield is only 1.68%.

OIH: This one tracks oil services companies with Halliburton (HAL) and Schlumberger (SLB) accounting for about 30% of the fund. It’s the most volatile of the bunch with an IV of 35%. And it’s the cheapest of the bunch due to its abysmal 5-year performance. The dividend yield is 2.19%

The Top 3 Energy Sector ETFs

Here’s a five-year weekly chart chronicling their performance versus the S&P 500. It’s one thing to go nowhere while SPY rips 57%. That would be terrible relative performance. But it’s much worse. Energy has descended to an entirely different level of hell. See for yourself.

In fairness to XLE, because of its tasty dividend (which isn’t reflected in the above chart), its overall performance hasn’t been near as bad as XOP and OIH.

The million-dollar question is whether or not the energy sector is in a secular decline or a more garden variety cyclical downturn. The former would mean its best days are behind it and the likes of XOP and OIH will never return to their old heights ($84 & $58) due to seismic shifts in its industry’s fundamentals. That is the risk of bottom fishing here.

XOP is only $23, and OIH is $13, but that doesn’t mean that can’t still drop another 50% if the bloodletting continues. This is where proper position sizing and risk mitigation come in. More on that later.

Of course, XOP and OIH don’t need to return to their prior peaks for the trade idea to work. Even if they climbed halfway back to their heights, it would be a killer trade.

The Gambit

The riskiest way to fish for a bottom is buying shares of one of the ETFs straight-up. And then riding them down the tubes if the slide continues. I can think of much smarter ways

First, buy shares now with a plan to sell covered calls if support fails.

Second, sell covered calls immediately to reduce basis right off the bat. The downside is your reward is capped from the get-go.

Third, sell naked puts to start, perhaps with the intent of allowing assignment and converting to a covered call if the stock drops.

Fourth, scale-in to allow yourself the ability to dollar cost average if energy stocks fall further from here. Take that lemon and make some lemonade.

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