Picking the Bottom of the Barrel – $XOP

by CC April 12, 2016 1:59 pm • Commentary• Trade Updates

In early March we looked at the XOP etf made up of oil and gas producers and explorers. At the time it was finally starting to show signs of life after a brutal couple of years. The problem with bottom picking though, is you could find yourself in yet another head fake if wrong. Therefore we liked the idea of defined risk calendars where you could fade that possible near term head fake and set up to own upside farther out. Here was the trade idea and rationale:

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

At the end of March we updated the trade idea after the March calls had expired with two ways to roll for those in the trade (or similar trades):

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.

So both of these rolls made sense at the time but with the pop in the etf today (up 6% and through the 32 strike in April) and the upcoming OPEC meeting in Doha this weekend, I wanted to look at how to manage both rolls. First, let’s look at the June roll.

Selling the June 35 calls made the position a June 30/35 call spread for a cost basis of 0.80. With the stock now 33.25 that call spread is worth about 2.90. That’s more than a double from the initial risk of 1.40 so it’s a nice trade and working well. Staying in the trade or exiting for the profit now is a matter of conviction on whether the etf can complete its breakout above the 200 day moving average of 33.86:

Screen Shot 2016-04-12 at 11.13.09 AM
6 month XOP from LiveVol Pro

The best trade management is to give the etf a shot to break above that level and if it fails know that you can take the trade off for a nice profit. And for those worried about big moves in this space after this weekend’s OPEC meeting it could be a good opportunity to sell half or all to reduce risk.

Now let’s look at the other roll possibility which was rolling the short March 30 calls out a month and up a few dollars to the April 32s, creating a call spread vertical calendar. That trade idea looked great until today’s move above 32, and now the short 32 calls are costing the position money if the etf goes higher from here, which was not intention (being short deltas). But profits are still there, similar to the other roll. With the etf at 33.25 this trade is worth about 2.80. So it’s not costing much in profits yet, but it will lose profits if the etf goes higher from here, unlike the June call spread, which makes money if the etf goes higher.

So the management on this trade is the opposite from the June call spread. You could of course take the trade off here for the double from the initial cost basis. Or if you think this move today is too far too fast, a pullback towards 32 actually increases profits on this trade (it is short 7 deltas) with 32 being the ideal spot this Friday. Assuming it closes above 32 this Friday the short April strike must be dealt with or else it becomes short stock vs the long June call.

So both rolls produced about the same profits as XOP continued higher, but the trade management from here on out is very different, especially with the short April call expiring this week and possible volatility we may see in energy related stocks with the OPEC meeting this weekend.