Chart of the Day – $XOP: Passing Gas

by Dan July 14, 2015 1:51 pm • Chart of the Day• Commentary

On a day that a nuclear energy deal was announced for Iran, which will release the country from stiff sanctions and allow them to sell their oil to a much wider swath of countries, many would have thought that crude oil would have been down sharply, as the last thing the commodity needs is more supply.  Well, it turned out to be a little sell the rumor and buy the news, with crude oil futures up more than 1% as I write, with Nymex crude up almost 4.5% from its intra-day lows.

Options volume is running pretty hot today in the XOP, the S&P Oil & Gas etf, with total volume 2x average daily.  Two thirds of the volume came in one bullish trade where a trader sold a downside put in December to help finance the purchase of an upside call spread, also in December:

Here was the trade when the etf was $45.11:

-Sold to open 20,000 Dec 39 puts at at 1.40

-Bought to open 20,000 Dec 47 calls for 2.55

-Sold to open 20,000 Dec 52 calls at .92

The total cost of the trade was 23 cents, which was $460,000 in premium.

Here is how the trade makes and loses money:

Profits: between 47.23 and 52 make up to 4.77 with a max gain of 4.77 above 52

Losses: between 47.23 and 39 lose 23 cents, or $460,000, below 39 lose the premium paid plus losses one for one on the stock, 2 million shares.

This trade makes a lot of sense for those looking for leverage for a fairly modest move back to the low $50s, but willing to be put the stock below the 52 week lows at $39, down 13% from current levels.  If the commodity continues to stay volatile, and the related stocks trade in the existing range for the second half of the year then this structure makes sense.

Taking a quick look at the 2 year chart, the low $40s has the potential to be a double bottom for the shares, with a bit of technical resistance in the low $50s, where the etf broke down to in late 2015:

XOP 2yr chart from Bloomberg
XOP 2yr chart from Bloomberg

Rarely do we do naked put sales on the site, as we don’t think they are suitable for most retail investors.  I want to be clear here, selling puts is probably the most consistent way to make money with options. And in a case like this where those proceeds are used to buy an upside call spread the trader has taken away most of their premium risk. But the risks of naked sales of puts are not always adequately appreciated by retail investors and many often miss-size their positioning.

If you are to use this strategy the sizing needs to be precisely the amount of shares you are willing to own if the stock (or etf in this case) declines precipitously and the losses you incur are what you’d be willing to take on as if you were long stock. The difference in this strategy (and the value of it) is although the margin required is similar to that of long stock it provides a range to the downside which you are able to withstand a decline without losses like stock (on December expiration). Therefore it’s a strategy best viewed as a stock alternative where you are a bit unsure of entry, not as a leverage play.