As a barrel of oil inches towards US$50 per barrel, share prices of Canadian energy companies have fallen in tandem. Sliding demand, high costs, and tight credit have all taken their toll on the energy complex. At least near term.

But have share prices dropped too far? Certainly hedge funds and other large pools of capital have been liquidating commodity positions to meet growing cash requirements and quarterly redemptions. Which has put a great deal of sentiment-driven downward pressure on all resource issues, including, most notably, energy.

But really… global energy demand has not disappeared. The global economy has slowed, but emerging economies like India and China, continue to grow albeit at a slower pace. Assuming that we have not suddenly displaced the business cycle with a continuous round of downsizing, there will come a point when the recession will end. At which time, you have to think that energy companies will rebound. Perhaps sooner than later, if this downside push has been overdone.

One trade in the sector that looks particularly interesting for aggressive traders is a covered straddle on Canadian Natural Resources (TSX: CNQ, recent price $48).

As an option candidate CNQ is interesting, because it is more volatile than the typical stock in this sector. The longer term options on CNQ, for example, are still trading at implied volatilities in excess of 90%.

At its current price of $48.00, the covered straddle involves the purchase of the shares plus the sale of both at-the-money calls and puts. The short call obligates you to deliver your initial block of shares to the call buyer if the stock rises, the short put obligates you to buy an additional block of shares if the stock declines. The latter point is important, because the risk is that you end up with twice as many shares, albeit at an average price that is below the current market price.

In terms of the strategy, buy say, 500 shares of CNQ at $48.00. You would then write the CNQ March 48 calls at $10.60 and the March 48 puts at $10.55 for a net credit of $21.15. The credit from the sale of the calls and puts reduces the out-of-pocket cost for your initial 500 shares of CNQ to $26.85.

In March 2009, one of two scenarios will play out; the stock will either be above or below $48 per share. If the stock rises, the calls will be assigned, and the puts will expire worthless. At that point, you would deliver your shares to the call buyer and receive $48 per share. Your return on this position is the sale price divided by the out-of-pocket cost for the initial block of shares, which translates into 78.8% over four months.

If CNQ is lower next March, the calls will expire worthless and the puts will be assigned. Under this scenario, you will be required to buy another 500 shares of CNQ at the strike price of the puts. Under this scenario, you would own 1,000 shares of CNQ at an average cost of $37.425. The average cost is calculated as $26.85 out-of-pocket cost for the initial 500 shares + $48.00 for the shares purchased as a result of a put assignment, divided by 2.