A Better Way Play Nat Gas

Published on Thursday, 23 February 2012 22:07 Written by Todd Shriber

New York, February 23^rd (TradersHuddle.com) – We previously discussed the virtues, or shall we say lack thereof regarding the U.S. Natural Gas Fund (NYSE: UNG), an ETF that is easily one of the most controversial on the market. No reverse split designed to artificially inflate UNG’s price is going to make us change our minds. We also mentioned the First Trust ISE-Revere Natural Gas Index Fund (NYSE: FCG) as one way for investors to get some natural gas exposure with out dealing with the risks of UNG.

Add to that list of better natural gas plays the highly volatile SPDR S&P Oil & Gas Exploration & Production ETF (NYSE: XOP). While XOP shares the SPDR brand with some other famous funds, do NOT confuse this ETF with the Energy Select SPDR (NYSE: XLE) because they share little in common. In fact, XOP is even higher beta than XLE and that’s because XOP isn’t heavily allocated to integrated oil stocks. Yes, names like Exxon Mobil (NYSE: XOM) and Occidental Petroleum (NYSE: OXY) make appearances in XOP, but only on a token basis.

In this environment of soaring oil prices, XOP is actually the better play and the statistics prove that. XOP is up over 16% year-to-date compared to a 9.8% gain for XLE. The secret to that performance gap comes XOP’s composition. Home to over 70 stocks, no single name receives a weight of more than 3.84% in XOP. Fortunately, the stock that gets that allocation is Cobalt Energy (NYSE: CIE), which is up more than 87% year-to-date.

Those are really the types of stocks XOP focuses on. Mid-cap oil and gas exploration firms that are either big shale players looking for oil and gas reserves in far-off destinations such as Africa, or both. That gives XOP a beta of almost 1.3, well above XLE’s beta of 1.07. The beta combined with XOP’s deeper correlation to oil prices means XOP is a great ETF for short-term traders. Simply put, there are days when XOP can act like a leveraged ETF even though it’s not. Not to mention, XOP also has great premiums for options sellers compared to other non-leveraged ETFs.

Given XOP’s epic bounce from around $38 in October to over $61 today, some might view the ETF, as overbought and as measured by RSI, XOP is in fact overbought. Along those lines, it would be nice to see the ETF pullback to the high $50s so new positions can be initiated for a run to the $70s. The risk with that strategy is that with oil prices rising on an almost daily basis, an XOP pullback may not materialize.

The vitals: XOP, which came to market in 2006, has an expense ratio of 0.35% and assets under management of just over $1 billion.