Dan and I both agree that oil’s big up move on Friday was likely a one-hit wonder. Too many people are focused on policymaker action because of the experiences in 2010 and 2011, but 2012 IS different. This year we actually have synchronized slowing around the globe, and that’s much less amenable to quick policy action. Oil has already signaled that issue, but we see little on the horizon that changes that outlook. Today’s ISM is just another data point in support of lower oil prices.
Dan suggested that we play this with a put spread in XOM. I liked the macro theme, but wanted to play it with put spread in OXY. First off, both trades are very similar. It’s likely that if the XOM put spread makes money, then the OXY trade makes money, and vice versa. Secondly, with the stock prices almost identical, it’s easy for us to optically compare the risk/reward on potential put spreads.
The XOM Aug 82.5 / 77.5 put spread costs 0.99 with XOM trading at 84.60. The OXY Aug 82.5 / 77.5 put spread costs 1.25 with OXY trading at 85.10. So the XOM is certainly the better risk/reward, basically because it has a lower implied volatility that OXY. In other words, the market expects XOM future volatility to be much less than OXY (XOM August implied volatility is around 18, vs. around 30 for OXY). The beta of OXY is higher than the beta of XOM. That should be no surprise.
But I like the OXY trade more than the XOM. I traded OXY on the short side in May, mainly due to the technical setup, though I do think they’re overexposed to new investment in oil exploration. OXY and XOM are both 10 P/E names. They are in the same business. They are both large cap. So why would I rather pay 1.25 for a put spread in OXY rather than 0.95 for a put spread in XOM?
The market has already demonstrated its preference for XOM over OXY, and I see little in the short run to change that. Investors smarter than me see more safety in XOM than in OXY. Here’s the relative performance over the last 2 years:
Given that OXY is supposed to be the higher beta name, and given that the market is up 25% in the past 2 years, OXY’s massive underperformance is quite surprising. I’m of the opinion that OXY is a case of a very poor micro story, whereas Dan is playing the catch-up trade on XOM. I think if XOM gets anywhere near 77.50, OXY will be well below 77.50. But Dan is risking less to make more.
Dan and I made a friendly wager on this one. He bought the XOM spread and I bought the OXY spread. Whoever’s right has a bigger pocketbook at the end of the day, but it’s more about good ‘ol fashioned pride at this point. Bring it on Dan.
XOM ($84.75) Bought Aug 82.50 / 77.50 Put Spread for .95
- Bought 1 Aug 82.50 Put for 1.50
- Sold 1 Aug 77.50 Put at .55
Break-Even on Aug Expiration:
Profits btwn 81.55 and 77.50, gains up to 4.05, max gain of 4.05 at 77.50 or lower.
Losses of up to .95 btwn 81.55 and 82.50, with max loss of .95 at 82.50 or higher
OXY ($85) Bought Aug 82.50 / 77.50 Put Spread for 1.25
- Bought 1 Aug 82.50 Put for 2.60
- Sold 1 Aug 77.50 Put at 1.35
Break-Even on Aug Expiration:
Profits btwn 81.25 and 77.50, gains up to 3.75, max gain of 3.75 at 77.50 or lower.
Losses of up to 1.25 btwn 81.25 and 82.50, with max loss of 1.25 at 82.50 or higher