Energy due for a bounce? Trading for a comeback in the sector using options

Amidst a new S&P 500 all-time high and an ongoing government shutdown, an options strategist initiated a risk reversal trade on the Energy Select Sector SPDR Fund (XLE), selling the Nov 21 $89 put and buying the Nov 21 $90 call for a $0.05 credit. This strategy aims to capitalize on the perceived undervaluation of the lagging energy sector, which is heavily weighted towards Exxon, Chevron, and ConocoPhillips, by either acquiring shares at an effective price of $88.95 or capturing upside, while noting the potential for the shutdown to influence Fed rate cut decisions.

Analysis

Despite the S&P 500 reaching new all-time highs and a low VIX of 16 indicating muted market-wide concern over an ongoing government shutdown, significant performance dispersion exists among sectors. The energy sector, as tracked by the XLE ETF, is identified as a primary laggard in 2025, presenting a potential value opportunity. This bullish thesis is underpinned by the new administration's pro-drilling policy stance and the possibility that the shutdown could prompt the Federal Reserve to cut interest rates. A key structural characteristic of this trade is the heavy concentration of the XLE ETF, with nearly 50% of its holdings in just three companies: Exxon (XOM), Chevron (CVX), and ConocoPhillips (COP). The proposed strategy to capitalize on this is a risk reversal options trade—selling the Nov. 21 $89 put while buying the Nov. 21 $90 call for a net credit. This structure defines a clear bullish position, aiming to either capture upside appreciation or acquire a long position in the ETF at an effective price of $88.95, reflecting confidence in the sector's indispensable mega-cap constituents.

Key Decisions for Investors

• Investors should evaluate the energy sector as a potential contrarian investment, given its significant underperformance relative to the broader market's rally to all-time highs.
• A position in the XLE ETF must be viewed as a concentrated bet on its top three holdings (XOM, CVX, COP), requiring conviction in these specific companies rather than the diversified energy sector.
• Consider utilizing options, such as the described risk reversal, to construct a capital-efficient bullish position, but be prepared for the contingent liability of owning the underlying ETF if the price declines.
• Monitor the government shutdown's influence on Federal Reserve policy, as a resulting dovish shift on interest rates could serve as a positive catalyst for equities, including the lagging energy sector.