(Bloomberg) -- With energy stocks trading near all-time highs and oil climbing as well, hedge funds think they’ve found a trade to capitalize: Sell the shares and pour the profits into buying more crude.

Hedge funds have been selling US energy stocks for three straight weeks, according to prime brokerage data from Goldman Sachs Group Inc. The net allocation to energy also is well below historical levels, with energy now making up just 2.2% of overall US net exposure on Goldman’s prime brokerage book. And the sector’s long-short ratio has fallen to a five-year low.

Meanwhile, Brent crude is back around $90 a barrel, and the volume of bullish Brent options just surged past the record set in 2019. Traders are betting on further increases in oil prices after Israel vowed to respond to Iran’s weekend missile and drone attack. 

“We are seeing some lottery ticket buying in crude with June $250 call options as investors are actively hedging a tail event in the commodity” said Rebecca Babin, senior energy trader at CIBC Private Wealth Group. “Macro hedge funds are already pretty long crude due to the reinflation trade, and to hedge against geopolitical risks they use options rather then underlying crude.”

Energy stocks are rallying in 2024 after slumping through 2023. The group is up 13% to start the year, making it the second best performing sector in the S&P 500, ahead of information technology. However, those gains have some investors concerned that the stocks have gone too far, too fast.

Read: Big Oil Is Beating Big Tech as Eyes Turn to Crucial OPEC Meeting

“We’re getting to levels that feel really rich,” said Frank Monkam, senior portfolio manager at Antimo. “Some of the hedge funds are selling oil shares, but since there’s still quite a bit of geopolitical risk, it makes sense to buy some call options on oil to protect yourself to the upside” 

In the meantime, Wall Street strategists still see further upside for energy companies. Goldman Sachs Asset Management and Morgan Stanley recently upgraded the sector to overweight based on a combination of rising oil prices, upside in earnings revisions and “compelling valuations.”

“The historical dynamic with energy stocks is a like a boom-bust: oil runs, these stocks run and then, there’s a supply response causing prices to fall and these stocks drop,” said Walter Todd, chief investment officer at Greenwood Capital Associates, who owns stocks like Exxon Mobil Corp., ConocoPhillips and EOG Resources Inc. 

“Now the US oil companies have become much more capital disciplined, returns are higher and they’re very inexpensive relative to other parts of the market,” he added. “But could you see the oil stocks fall back in the short-term given the run they’ve had? Absolutely.” 

--With assistance from Alex Longley.

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