XLE – Oil Change

by riskreversal November 11, 2016 2:34 pm • Trade Ideas

On Wednesday (Big Printin’ – XOM Dec Calls) we highlighted some out of the money call buying in Dec expiration in Exxon (XOM):

XOM… saw some fairly heavy short dated call volume that was 2.5x that of average daily volume. The largest trade of the day was an opening buy of 10,00o of the Dec 90 calls for 49 cents when the stock was $85.80, with 39,000 trading in total on the day. These calls break-even up 5.5% from the trading level at $90.49, and is just above what could be near term technical resistance at which was the July break-down level.

Regular readers know that we don’t place a ton of emphasis on unusual options activity, without knowing the initiators intent, or what the options trade may be against. And it is usually impossible to assign any meaningful importance on the volume. But as you have become accustomed to, the acknowledgement of the big prints gets us thinking about the underlying and related securities.

For instance, XOM is 17% of the weight of the XLE, the S&P Energy Select etf where the top 5 holdings make up 50% of the weight.

The XLE has shown some very good relative strength to crude oil of late, with WTI trading at the lowest level since mid Sept, down about 16% from mid Oct, sitting right on its 200 day moving average:


[caption id="attachment_68098" align="aligncenter" width="600"]WTI Crude 1yr chart from Bloomberg WTI Crude 1yr chart from Bloomberg[/caption]

On the flip-side, the XLE is down less than 4% from its recent highs, and the technical set up is fairly constructive making a series of higher lows since mid April:

[caption id="attachment_68100" align="aligncenter" width="600"]XLE 1yr chart from Bloomberg XLE 1yr chart from Bloomberg[/caption]

Taking a slightly longer term view, $70-72 appears to be considerable technical resistance, but with little overhead resistance till about $80:

[caption id="attachment_68103" align="aligncenter" width="600"]XLE 5yr chart from Bloomberg XLE 5yr chart from Bloomberg[/caption]

Crude Oil has gotten slammed with production at all time highs, suspect demand, and prospects for a cut in production dwindling at OPEC’s Nov 30th meeting.  Oh and the dollar has also caught a bid as expectations for a Dec 14 rate increase by the Fed seems like a certainty and the latest push part of the post election risk on enthusiasm.

If Crude were to find a home in the mid $40s, if the dollar does not breakout, and if the Fed does not signal a series of rate increases, then oil stocks should be able to breakout and possibly establish a new range above the prior highs.

So what’s the trade?  Short dated options prices in the XLE have traded in a fairly tight range over the last few months, with the etf, while absolute levels of implied volatility in the XLE are not particularly high, it could become expensive to own premium in a low vol environment:

[caption id="attachment_68101" align="aligncenter" width="600"]XLE 1yr chart of 30 day at the money implied volatility from Bloomberg XLE 1yr chart of 30 day at the money implied volatility from Bloomberg[/caption]

So What’s the Trade?

XLE ($69.50) Buy the Jan 70/77 call spread for $2

  • Buy 1 Jan 70 call for 2.25
  • Sell 1 Jan 77 call at .25

Break-even on Jan expiration

Losses of up to 2 between 70 and 72 with max loss of 2 below 70

Gains of up to 5 between 72 and 77 with max gain at or above 77

Rationale – This trade is out of the money, but offers a decent risk reward if energy stocks break higher above their recent consolidation.