The Energy Select etf (XLE) has had a nice bounce from the lows of earlier this year, largely driven by a stabilization in energy prices that had been steadily declining over the past two years. The jury is still out on whether the lows we saw in January and February in the oil patch was the low, but some of the worries have abated for now. But as we said on March 17th, the reversal of the strong dollar (which had been one of the primary drivers of the decline in commodity prices since the end of QE) could just be a head fake. If that is the case sectors like XLE might be due for a pullback from recent strength. We placed a trade that day with that in mind, buying some time and financing June 60 puts with the sale of April puts of the same strike. Here was the trade and rationale at the time:
*XLE ($64.22) Buy April/June 60 Put Calendar for 1.40
- Sell to open 1 April 60 put at .55
- Buy to open 1 June 60 put for 1.95
Rationale: The ideal situation in this position is for XLE to pull back to $60 in the next month, without going too far below. If that happens the april put can be closed and either rolled to May to keep the calendar on or rolled into a downside put sale in June, creating a (same month) put spread. The risk is XLE continues higher or even goes sideways as the vol being bought in June is high historically (but down quite a bit from recently).
In that rationale we mentioned one of the risks of the calendar where we were buying June vol, that despite being down sharply recently, was still high historically. That has turned out to be fine for now as June implied vol is actually slightly higher than where we bought it. But we’ll have to keep an eye on it and be diligent. In the meantime, XLE has indeed pulled back a bit. With the etf at $61.30 this put calendar is worth about 1.70. So it’s working, but the April calls we’re short are worth 1.00 (we sold them at .55) and what happens in them next will be key to this trade.
If the XLE continues towards $60 over the next week or so, slowly, this trade will be in great shape. If we see an acceleration in the selling in the next few days that April put will stay pumped and it’s possible that the etf falls below the 60 strike too fast. There are worse things that can happen to you, because all that would mean is you have a profitable trade that you need to close for less than you hoped, but it is something to keep in mind as far as trade management. If we see $60 soon, we’d likely take the trade off for a profit. If we see the etf trade slowly down to that level over the next 2 weeks, that would be even better and we can be patient. The same goes for it going sideways as that $1 in April will decay quickly.
Right now the April 60 puts decay about .03 a day, while the June puts decay about .02. But, the June puts will continue to decay at about .02 a day while the April put’s decay will pick up its pace exponentially. That means every day the stock stays in this range near 60 this trade gets a little better. And the longer we can be patient the better the trade set-up gets. That’s especially true with the 3 day weekend ahead.