$XOP Oil Strike

by CC March 28, 2016 3:32 pm • Commentary• Trade Ideas

In the beginning of March we looked at the oil and gas explorer etf XOP. The XOP has gotten hammered over the past 2 years, from a high of about $85 in 2014 to a low of $22 in January 2016:

Screen Shot 2016-03-28 at 1.17.11 PM
2 yr XOP from LiveVol Pro

But in recent weeks these stocks have caught a bid as crude oil seemed to finally find some footing. But is it finally the bottom or simply a dead cat bounce? Hard to say. Therefore, instead of simply buying XOP, we liked the idea of fading the bounce in the near term for the possibility of owning a little farther out though the use of an upside call calendar. Here was the trade idea and rationale at the time:

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.

March has expired and with the stock higher, this position is simply a June call that is profitable (June 30 calls are 2.20 vs 1.40 cost). So what happens next depends on what one wanted to do with this trade. If the idea is to stay in the trade long term for continued strength in these stocks through the spring it’s probably a good time to spread the June calls to reduce some premium risk.

The June 35 calls are .60 and selling those means you can be long the June 30/35 call spread at a cost of .80 (currently worth 1.60). The other way to go about things is to roll the calendar up and out. The April 32 calls can be sold at .35. That reduces the total cost of the calendar to 1.05 and allows for room if XOP goes above $30 in the next few weeks. As $32 is now the ideal spot for the stock on April expiration. Assuming XOP is below $32 on April expiration, that calendar could continue to be rolled.