Go figure, a few of my worst trades this year were long biased and in oil related stocks/etfs (CVX, USO and XLE). Exhibit A and B to stick with what you know and don’t be contrarian for the sake of it. Live and learn, hopefully.
I was intially interested in the energy space earlier this summer as it felt despite what appeared to be weakening global demand with increasing supply that oil prices had been buoyed by geopolitical concerns. Well, when prices started to fall I felt smart for about a week, but when they started to crash I thought there was opportunity as once again maybe the downward volatility was the result of misplaced fears.
Yesterday crude oil made a new 52 week low, marking an almost 30% peak to trough decline from the 52 week highs made in June:
There were some obvious round numbers where technicians thought the commodity should find support, but 95 went to 90 to 85 to 80. Now there are calls for $70 oil. Today’s reversal, up 2% has caused some speculation in oil stocks, and there was an options trade in the XLE (the Energy Select etf) that caught my eye.
When the etf was $85.53, a trader bought the XLE Dec 90 / 95 / 100 Call Butterfly 10,000 by 20,000 by 10,000 to open for .63, or $630,000 in premium.
The trade breaks event at $90.63, up about 7%, with a max gain of $4.37, or $4.37 million at $95, up about 11%, with gains of up to $4.37 between $95 and $99.37. Max loss of .63 below 90 and above 100.
So with the break-even so far out of the money, its easy to call this sort of trade strucutre speculative. The trader was ovbiously looking to risk as little as possible but define a wide range to the upside where the trade could be profitable to the tune of a multiple of what was risked (close to 7 to 1 at max gain).
So why a call butterfly? The trader bought one of the 90s and sold 2 of the 95s and one of the 100s. The reason one would do this would be to take advantage of elevated options prices and help offset any decline in extrinsic premium decay in the 90 strike that he is long.
So to sum up, XLE implied volatility, while in a bit from the 52 week highs that was more than a three fold increase from the recent 52 week lows in Sept, is still elevated and that those looking to make directional bets should continue to look for strategies that look to offset potential decay.
And lastly, why options? Obviously the leverage, but also likely for defined risk. Just because we have had a little consolidation around $85 over the last couple weeks, the technicals are far from giving the all clear. The two year chart below shows the importance of the $85 level, and another failure here would once again put $80 in the crosshairs: