Crude looks like it is entering its own type of recession this year, with the International Energy Agency predicting a fall in oil consumption for the first time in 25 years. But David Newman still thinks there are huge profits to be had in the oil industry. He recommends an Oil & Gas ETF (NYSE:IEO) and Oil Services ETF (NYSE:OIH), using a ‘protective put strategy’ to cover against downside risk.

This from The Sovereign Society:

The oil industry is a tricky business.

I know. I was a well-site geologist for many years. Just like the stock market, sometimes the best-looking prospects are your worst duds and those you were not too sure about gush profits.

It’s a gamble, but one that can pay off big if you’re right. But what if you’re wrong? Well in the old days it was watch out below… but now, I know of a strategy that can insure against some of your losses.

I call it “PPS” and it has helped me out many times in the past. Let me explain…

Right now I’m looking again at the oil, gas and the service industry. They’ve been beaten up pretty badly. As the price of oil has dropped from $147 a barrel to below $40 last week, any company that is even remotely associated with the industry has seen it share price tumble.

The major oil companies like ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP) have seen their stock prices pull back as much as 50% from their 52-week highs. Schlumberger (NYSE:SLB), which traded as high as $111.95 this year, is now at $41.91. Baker Hughes (NYSE:BHI) down from $90 to $30 and Transocean (NYSE:RIG) has fallen from $163 all the way down to $55.

These are great companies in great industries. And no matter the environmentalists want you to believe, they won’t be going away for a long, long time.

They have war chests full of profits from the recent run-up in oil prices. They don’t need much outside financing and can wait out the economy. They’ll invest in themselves just as they’ve always done. They’ll push the limits of technology and invest in people.

And if President elect Obama has his way, and I believe he will, then we’re also going to see massive infrastructure construction projects begin next year. As we put people back to work, as money again begins to flow oil prices should begin to drift higher.

So if you want to profit as the industry turns up you should look at the iShares Dow Jones US Oil & Gas Index ETF (NYSE:IEO) and the HOLDRS Oil Services ETF (NYSE:OIH). These two ETFs will give you broad exposure across the industry.

Then to protect your downside I suggest you look at my “PPS” or Protective Put Strategy. Using this strategy, you’re going to buy one put for every 100 shares of these ETF’s. Now, to keep your cost down look to buy in the nearest month or two and look at the put options about 20% below your share purchase price.

As an example – if the HOLDRS Oil Services (OIH) were trading at about $70 per share like it was today and I was going to use this strategy I would buy 100 shares of OIH and then immediately buy an OIH protective put. I would buy the Jan OIH 55 symbol OIDMK for about $2.35.

This strategy cost a little more then just buying the long position but I’ll tell you, do it and you will sleep better at night. It’s the same as paying $72.35 for the shares and if they take off (like I think they might) the extra $2.35 becomes almost irrelevant…but if I’m wrong I’ve covered my assets.

Source: Striking it rich on Oil…without getting Burned