Name That Trade – $XLE: Crude Set Up

by Dan March 11, 2014 3:32 pm • Commentary

Crude oil is trading at its lowest level in almost a month, below its 200 day moving average and the psychologically important $100 level.

Crude Oil Futures chart 1y from Bloomberg
Crude Oil Futures chart 1y from Bloomberg

The commodity first saw a ramp a couple weeks ago as tensions started to heat up between Russia and the Ukraine, but has since given back all gains, likely to do with what appears to be a dreadful demand picture from emerging markets, particularly China.

Oil stocks have been a mixed bag of late and certainly a bit volatile with a couple high profile guidance disappointments from two giants, XOM and CVX.  The two stocks combined make up almost 30% of the XLE, the Energy Select etf.

The six month chart below shows the etf’s failure at the 2 prior highs from Jan and Dec, and today’s rejection that could mark a nasty triple top.  In the near term, a meaningful decline in the underlying commodity could signal a retest of the next obvious support level at the 200 day  moving average at $84.

XLE 6 month chart from Bloomberg
XLE 6 month chart from Bloomberg

I want to make a defined risk bet that the weak demand picture will outweigh any increased tensions in the Ukrainie and that the XLE will re-trace a good bit of its recent bounce off of the February lows, but not at this exact moment, its hard to press a short on a down day like this.  On the first bounce, possibly tomorrow morning, I will look to establish the following trade:

Hypothetical Trade: XLE ($87.15 ) Buy the April 88/84/80 put fly for 1.00

– Buyto open one Apr 88 put for 2.50

– Sell 2 April 84 puts at .90 (1.80 total)

– Buy 1 April 80 put for .30

Break-Even on April Expiration:

Profits: btwn 87 and 81 make up to 3.00 with max gain of 3.00 at 84

Loses: btwn 87 and 88 & btwn 81 and 80 lose up to 1, max loss of 1 above 88 and below 80

Rationale – We don;t love the timing of this trade near the end of the down day and would love to time this trade on an up open. If we saw a big enough up open it’s possible we’d widen the strikes a bit.