New Trade – $XOM: Dead Tiger Bounce

by Dan October 9, 2015 1:02 pm • Commentary

Our worst trade of 2014 was trying to pick a bottom late last summer in the USO (the U.S. oil fund etf) when Crude Oil had just broken $100 on the downside (here, but only read on an empty stomach).   Since then we avoided the oil patch as it had become apparent that something real was going on.

This past Summer we had two profitable trades in single stocks (XOM here & SLB here) based on the recognition that the conditions that caused the crash in oil had not abated and that the technical set up looked downright awful as both stocks remained in sharp downtrends sitting on important long term support.

The bounce in the commodity of late has caused a massive short covering rally in beaten down stocks in the energy space. I suspect that the recent bounce has erased a good bit of bearish short term sentiment. And now that could set up for a great short trade entry as large integrated oils get ready to report Q4 guidance in the coming weeks.

We do our best to be patient when pressing a short, and look to do so at what we feel like are obvious entry points. XOM is near the downtrend, and in this case that also corresponds with prior support (now resistance):

XOM 5 year chart from Bloomberg
XOM 5 year chart from Bloomberg

Options prices had been very low (despite the stock’s steady decline for most of the year) leading up to the volatility spike in August, and they have since come in hard. Prices will likely stay bid from here until there is more clarity on global growth:

XOM 1yr chart of 30 day at the money Implied Volatility from Bloomberg
XOM 1yr chart of 30 day at the money Implied Volatility from Bloomberg

I would expect a decrease at best in IV to the high teens in the near term.

To be clear, XOM is a cheap stock, with poor sentiment and a 3.67% dividend yield with little buyback support.  Also, consensus estimates call for an expected 50% eps decline this year from last, not far off from the 53% decline in eps from 2008 to 2009 before bouncing 55% in 2010.   Consensus is only pricing a 9% eps increase in 2016.  So sentiment still sucks despite the bounce. But it may have shifted too quickly given the lack of news and the potential for downbeat guidance and increasingly poor data as it relates to global growth.

I want to make a defined risk short into earnings.

Trade: XOM ($79.50) Buy Nov 77.50 / 70 Put Spread for 1.45

-Buy to open 1 Nov 77.50 put 1.90

-Sell to open 1 Nov 70 put at .45

Break-Even on Nov Expiration:

Losses: of up to 1.45 between 77.50 and 76.05, max loss above 77.50.

Profits: up to 6.05 between 76.05  and $70 with max gain of $6.05 at $70 or lower.

Rationale – XOM’s bounce has been nothing short of impressive in October, up 7%.  But it feels that large capital pools are trying to play a little catch up despite any change in fundamental news.  The move back to the downtrend, combined with the decrease in short dated options prices set up for a good entry for a defined risk short trade into earnings.