$XOP Tick

by Dan March 3, 2016 3:16 pm • Commentary• Trade Ideas

As the broad market broke out above some key near term technical resistance earlier in the week, and crude oil has stabilized in the low to mid $30s, there has been some fairly speculative buying in some beaten up high short interest energy related stocks.  Here are a few that caught my eye today.

  • Chesapeake (CHK) is up 28% today, up 60% this week, and up 180% from its Feb 11th lows, while still down 75% from its 52 week highs.
  • U.S. Steel (X) is up 9% today, up 90% from its February lows, and up 50% this week, but still down 55% from its 52 week highs.
  • Joy Global (JOY) is up 17% today, up 24% this week, up 85% from its 2016 lows, but still down 65% from its 52 week highs.

This sort of buying after such a sharp rally off of the lows for the broad market smacks of desperation by those chasing any sort of near term performance.  If you are a nimble trader, catching these sorts of short squeezes in unloved stocks with high short interest with no real identifiable fundamental improvement is certainly one way to make money, but do remember why these stocks are down so much, their exposure to commodities and their heavy debt loads. Individually, each one of the companies could be subject to a tape-bomb at any moment and if they get back to the prior lows, they could go into a death spiral.

For me it makes more sense to mitigate idiosyncratic risk and look at an etf like the XOP, the S&P Oil & Gas etf which is made up of a little more than 100 stocks, with none having more than a 3.5% weight.

The XOP is down 12% in 2016, down 46% over the last year, and down 67% from its all time highs made in 2014.  The downtrend is severe, and the potential for a short squeeze at any point is large, which is why bottom pickers in energy stocks might want to consider the XOP as opposed to individual names:

XOP 5 year chart from Bloomberg
XOP 5 year chart from Bloomberg

On a near-term basis I could clearly see a move back to the etf’s 150 day moving average, which happens to be a breakdown level from early December top about $33:

XOP 1yr chart From Bloomberg
XOP 1yr chart From Bloomberg

So What’s the Trade?

You want to define your risk and be there for a potential break out above recent resistance. But some components are already starting to short squeeze, so you don’t want to chase. One way to be there and not get whipsawed is to to fade the very near term to help finance a few months out.

In lieu of 100 shares of XOP ($28) Buy the March/June 30 call calendar for 1.40
  • Sell 1 March 30 call at .27
  • Buy 1 June 30 call for 1.67

Rationale – This strategy risks 1.40 and looks out until June expiration. Any move between now and March expiration just 2 weeks away towards $30 means the trade is profitable. A short term reversal lower and the trade is a loser but the short March call helps mitigate that risk as it will expire worthless. If the stock is flat or slightly higher in the next two weeks the March call can be closed or let expire worthless and the June calls can be spread. Call calendars can be useful in cases where you may have missed part of a short term move, are afraid of entering and being immediately wrong but would like to be there later.