Trade Update – $CVX: Taking Off Risk Reversal For a Loss

by Dan October 9, 2014 12:53 pm • Commentary

Given the severe oversold nature of the oil sector last week, we put on a couple of trades that were designed to play for a bounce from severe oversold conditions.  However, today’s selling has taken XLE down to a new low:

XLE daily chart, courtesy of Bloomberg
XLE daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg

Given the aggressiveness of the recent selling, and the severe underperformance compared to the broader market, a sustainable bounce in the near term is looking less and less likely.

With that in mind, we’re going to take off one of the two bullish trades in energy equities that we initiated last week.  We’d rather get out of our CVX risk reversal for a loss today, and keep our bullish XLE options structure (full XLE post here), because the XLE trade has limited risk, whereas the CVX position is open-ended risk.  With that in mind, we just got out of the CVX risk reversal:

ACTION:  CVX ($115) Bought back the Jan15 110 put for $3.10 to close, sold the Jan15 120 call at $2.04 to close, for a $1.06 debit, for a total loss of $2.01 on the position



New Trade – $CVX: Oil Change

Despite no shortage of geopolitical headlines that could cause supply shocks in the crude oil market, the price of the commodity has seen a precipitous drop (down about 16%) from the 52 week highs made in mid June to new 52 week lows this week:

Crude Oil Futures 1yr chart from Bloomberg
Crude Oil Futures 1yr chart from Bloomberg

Back In late August, we initiated a bullish trade in USO that defined a wide range between now and January expiration where we would gain long exposure in to the etf that tracks the price of WTI Crude oil (read here).  Since we placed the trade, the etf is down 3%, the commodity is down about 4% and our trade is down about 1.5% of the underlying etf.  We are keeping a close eye on the position, but we think the set up is not horrible given the increasingly oversold nature of the sector and what seems to be a growing consensus of lower oil.

While it takes a much savvier macro soul than I to figure out the money flows in and out of some of the most economically sensitive risk assets on the planet, the stocks of the companies that refine the raw material are another scenario all together.

For instance, Chevron’s (CVX) shares have declined about 12% from the all time highs made in late July, now approaching a fairly oversold technical condition:

CVX 2yr chart from Bloomberg
CVX 2yr chart from Bloomberg

For the better part of the last 2 years, CVX has traded above $115, with the March 2014 low looking like a sort of dream entry level on the long side.

With the stock’s persistent decline, implied volatility (the price of options) has risen from a matched multi-year low in late August to a yearly high just this week:

CVX 30 day implied volatility, courtesy of Bloomberg
CVX 30 day implied volatility, courtesy of Bloomberg

For those looking to play for a rebound in CVX shares using the elevated levels of implied volatility to finance the purchase of upside calls is a fairly attractive way to do so.  While $115 looks like a decent level to stick your toe in on the long side, $110 would be the level in the event of a panic that would mark an entire round-trip from the 52 week lows to the all time highs and back.  This is the level that we want to make sort of line in the sand for the trade under what we would define as a high probability long from that level.

So here is the trade:

TRADE:  CVX ($117.75) Bought Jan15 110 / 120 Risk Reversal for 0.95

-Sold to Open 1 CVX Jan15 110 put at 2.05

-Bought to Open 1 CVX Jan15 120 call for 2.95

Break-Even on Jan15 Expiration:

Profits: 1 for 1 with the stock above 120.95

Loses: Between 110 and 120, lose 0.95; between 120 and 120.95, lose up to 0.95; below 110, lose dollar for dollar with stock plus the 0.95

Rationale:  CVX has traded above $110 since late 2012, and trades at a discounted valuation relative to its largest peer, XOM (a slight discount on P/E, a larger discount on a EV/EBITDA basis).  The stock is quite cheap vs. the broader market as well.  The risk reversal is a much lower risk way to get long CVX here rather than simply buy the stock.