MorningWord Sept 11, 2014: Oil Spill – $XLE

by Dan September 11, 2014 8:43 am • Commentary

We often highlight unusual options activity, not because we have the intent of following, but more importantly as a gauge of sentiment and to get a better sense for large movements in capital flows.  Yesterday morning, there was a large bearish roll in the Energy Select etf (XLE), where shortly after the open when the etf was trading  $94.11, a trader sold 28,000 of the Oct 95 puts at 2.45 to close ($6.8 million in premium) and bought 28,000 of the Oct 93 puts for 1.60 to open ($4.5 million) in premium.

Unless you have intimate knowledge of the trade, the intention of the trader is hard to just guess.  Could it be rolling an outright bearish view of large cap energy stocks? Sure. Could it be a hedge against a long portfolio of large cap energy stocks? Sure.  Could it be a hedge against a sector weighting in a broad portfolio of large cap etfs? Sure.  Point is, arriving at an immediate negative conclusion because it was a sizable put purchase is not always the right conclusion.

What’s interesting about the trade to me was the increasingly bearish sentiment towards crude oil the commodity and subsequently many of the components of the XLE, which are obviously a bit levered to movements of oil. Looking at the components of XLE, it is easy to see how this is a trading vehicle very much tied to the performance of a few stocks, with XOM, CVX, SLB, COP, EOG , OXY, HAL & PXD making up 50% of the weight, and XOM and CVX making up 28% alone.

Sentiment in oil and related stocks could not be worse right now, with many pundits calling for $85 a barrel soon, well below the 52 week lows.  Large integrated oil stocks like XOM have gone from all time highs in late July to breakdown levels in no time.

I would mention that while yesterday’s put roll in the XLE was notable from a premium standpoint, the etf rallied more than 1% from the lows of the day, closing near the highs of the day (despite closing down), on reasonable volume, which could have signaled a short term reversal.  Options pricing in XLE has moved higher this month on the sector’s weakness, as Enis mentioned in today’s Notable Options post:

XLE 30 day implied volatility has bounced sharply in the past 2 weeks as the ETF has sold off nearly 4% in September:

XLE 30 day implied volatility, courtesy of Bloomberg

The year to date chart below of the XLE shows the etf’s breakdown yesterday, below important near term support, below the early June breakout level, but also the August lows.  Importantly though, the etf reversed as noted above, and closed just below the all important $95 support/resistance level:

XLE ytd chart from Bloomberg
XLE ytd chart from Bloomberg

Put another way, the chart is at a fairly precarious position. With crude indicated lower after President Obama’s declaration of war on ISIS last night, the XLE is also indicated lower.  A failure to break above $95 could signal a new resistance level, while the potential of another reversal and close above $95 could be the start of an important sentiment shift towards the sector.