Trade Update $XLE – Adjustment Time

by Enis April 25, 2013 3:16 pm • Commentary

Trade Update April 25th, 2013, 3:16 pm:  I am adjusting my XLE trade from last week.  

XLE rallied straight up after I initiated this put trade last week.  But the ETF tagged its 50 day ma today and has broken back below it, and crude oil has also rallied up to its 50 day, and is a potential area where sellers become more active.  Add to that the fact that XLE’s largest component, XOM, is down today after earnings, and I am going to roll my put strike up in May, playing for weakness from here, and looking to salvage the premium from my initial trade as well.  Normally I don’t like to add premium to loser unless it’s a very small amount or I have a lot of conviction.  This falls in the second category.

Action: Bought the XLE ($77.37) May 77/73.50 Put Spread for $0.80
New Position:  Long the May 77 Put for $2.10

Original Post April 19, 2013:  New Trade $XLE – Energy Stocks Look Cheap, But What About Oil

Energy stocks are relatively cheap vs. the market on a P/E basis.  Particularly when I look at the XLE ETF, it’s composed of the largest oil and gas names, the recognizable behemoths of XOM, CVX, and COP, paying decent dividends at 10x P/E valuation.

However, energy has not seen the flow of funds that the health care, consumer staples, and utilities sectors have seen.  It’s an underperforming sector this year, and investors clearly put it in a separate bucket than the other high-yielding sectors.  Appropriately so in my view, as oil prices are showing serious signs of cracking.

On a fundamental level, oil inventories are very, very high.  Here is Bespoke’s chart showing how 2013 inventories are tracking far above prior years:

Screen Shot 2013-04-19 at 10.13.33 AM

In terms of XLE’s relationship to oil, I posted a Chart of the Day last week comparing oil’s performance vs. XLE over the last 3 years.  Here were my thoughts:

How about oil-related stocks?  They’ve performed much better than the commodity itself in the past year, participating in the broader market rally.  Here is the 3 year performance chart of XLE vs. WTI front month oil, illustrating the percentage gain in each asset since April 2010:

3 year performance chart of XLE vs. CL1, Courtesy of Bloomberg

3 year performance chart of XLE vs. CL1, Courtesy of Bloomberg

This performance gap really started to widen in the second half of 2012, and has continued into 2013 as well.  Part of this is due to relatively cheap overall valuations in the energy sector compared to other cyclical sectors, and the value trade has been in vogue in the past 6 months (see health care’s strength).  Part of it is simply due to stocks’ outperformance as an asset class.  Yet, oil stocks are discounting a much more optimistic future than a year ago, when crude oil prices were in the same spot

On the 3 year chart of XLE, we can see that it was once again rejected around the 80 level, similar to 2011:

[caption id="attachment_24968" align="alignnone" width="624"]XLE 3 year daily chart, Courtesy of Bloomberg XLE 3 year daily chart, Courtesy of Bloomberg[/caption]

On a shorter-term basis, I’ve drawn the smaller red line to denote the 76 area that had served as support for most of the past 3 months.  That support broke this week, and sent XLE all the way down to its 200 day ma, from where it has bounced the last 2 days.  The bounce looks like a dead cat bounce given all the overhead supply though, and oil’s inability to rally this week is another sign to me that XLE is close to breaking its 200 day ma to the downside.  That has resulted in some very quick moves over the past few years for this ETF, and I want to play for a potential break, with today’s bounce offering a decent entry.

TRADE: XLE ($74.60) Bought the May 73.50 Put for $1.30

-Bought 1 May 73.50 Put for 1.30

Break evens on May Expiration:

-Losses of up 1.30 between 72.20 and 73.50, max loss of 1.30 at 73.50 or above

-Profits below 72.20

Trade Rationale:   This is a trade anticipating a break of the 200 day ma, and a resulting fast move lower.  XLE has been a leader on the downside this week, and given oil’s continued weakness and poor fundamental backdrop, I expect XLE to continue to lead to the downside in the next month.