Crude oil prices have been down every day this year, falling some 16% so far in just six trading days. Oil prices traded below $31 per barrel yesterday, and are now at levels last seen in 2003.
Many traders (myself included) are looking for oil prices to find a value floor somewhere near current levels. But rather than playing oil futures or options, I prefer to use Exxon Mobil Corporation (NYSE:XOM) stock as a better way to play the expected consolidation in crude pricing.
There are 42 gallons in a barrel of oil, and with WTI spot crude closing at $31.13, this puts the price of oil at roughly 75 cents a gallon. To put things in perspective, a gallon of water at the store costs about a buck … so from a commonsense standpoint, oil prices seem pretty cheap to me at present.
Click to Enlarge Exxon Mobil stock is, as one would imagine, highly correlated to the price of oil. However, XOM shares have been a relative outperformer to oil over the past few months — and I look for this relative outperformance to continue.
Unlike smaller oil companies, Exxon Mobil is highly integrated, with upstream (exploration and drilling), midstream (transporting and storage) and downstream (refining and marketing) operations. While lower oil prices are a detriment to upstream, these same lower prices provide a benefit to the downstream component of XOM, helping to buffer somewhat against lower oil.
While many other producers hedge their oil exposure via futures or swaps, Exxon Mobil does not hedge its production. This means Exxon Mobil stock should feel the benefit of any appreciation in crude prices to a larger degree than the hedged producers.
XOM stock also has a very healthy dividend yield of 4%, handily outpacing the 2.2% yield for the S&P 500. Exxon Mobil is doling a little bit more than 80% of next year’s estimated earnings out in dividends, so the payout isn’t really in danger, either.
Click to Enlarge From a technical standpoint, XOM stock has solid support at the $72 level, with the stock getting oversold on a 9-day RSI basis. Implied volatility also has spiked, which has been a solid indicator of a short-term low over the past year.
How to Trade Exxon Mobil Stock Here
With IV at elevated levels, selling an out-of-the money put spread is my favored strategy to position for limited downside from current levels on both crude oil and Exxon Mobil stock.
Specifically, I would sell the XOM Feb $70 puts and buy the XOM Feb $67.50 puts for a 50-cent net credit.
The short strike is structured below the $72 support level, providing a 5% downside cushion to Monday’s $73.67 closing price of Exxon Mobil stock. The maximum gain is the $50 net credit received for each spread sold, with a maximum loss of $200 per spread. The return on risk is 25%.
I would look to close out the spread on a meaningful break of the $72 support level. Obviously, we’re hoping that Exxon Mobil stock remains well-behaved and that the spread expires worthless so we can keep that initial $50 net credit.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
