Crude oil has moved higher through resistance at $34, and major overhead resistance isn’t much higher (at $38), and so a little consolidation in oil prices and oil stocks looks likely here.
It would be warranted: Supply concerns still are weighing heavily on the oil market, and we’re still experiencing slowing economic growth out of major oil consumers like China.
In my previous article on major oil stocks, I highlighted a way to play crude oil using put option credit spreads on Big Oil companies. While I was somewhat bullish back then, the recent rally in these oil stocks has left them extended, so my previously guarded bullishness has switched to something a little more grizzly.
Since the recent high on Jan. 29, crude oil has failed on three occasions to break past the $34 resistance, while the major oil stocks have continued their rally. I am now somewhat bearish on oil stocks, especially given their recent out-performance to crude and my neutral to bearish outlook on oil prices.
Looking at the three biggest components in the Energy SPDR (XLE) — Exxon Mobil Corporation (XOM), Chevron Corporation (CVX) and Schlumberger Limited (SLB) — I have a few ways to play a stall in the rally.
Oil Stocks: Exxon Mobil Corporation (XOM)
Click to Enlarge Exxon Mobil (XOM) has put in an impressive rally since crude oil peaked on Jan. 29, moving higher by 5.83% even with crude oil falling 1.16% in that same time frame.
The chart highlights this divergence, which I expect to revert back towards the mean.
Given my neutral-to-slightly bearish outlook on crude going forward, I look for XOM to struggle to head higher over the coming few weeks.
Technically, XOM stock is getting close to overbought on a 9-day Relative Strength Index basis, and implied volatility — a good contrary indicator — is at recent lows. This supports the case that XOM will have difficulty continuing this rally.
Looking out to regular March options, I would position by selling the March $85 calls and buying the March $87 calls for a 50-cent net credit. The breakeven point on the trade is $85.50, which corresponds to overhead resistance at the $85 level in XOM, providing a 3.7% upside cushion from the current $82.39 price.
The maximum gain on the trade is 50 cents, or $50 per contract, with a maximum risk of $1.50, or $150 per spread. Return on risk is 33.33%.
I would close out the trade on a meaningful break of the $85 resistance level, while looking to have the spread expire worthless and retain the initial $50 credit if XOM remains well-behaved.
Oil Stocks: Chevron Corporation (CVX)
Click to Enlarge Chevron (CVX) has also had a solid rally since Jan. 29, rising nearly 3%. The chart shows a similar divergence to the previous chart in Exxon, and I expect CVX to struggle in a very similar fashion to XOM over the next several weeks.
From a technical perspective, CVX is also approaching overbought levels and implied volatility has cratered, pointing to a high likelihood that the rally in Chevron will temper.
Again looking out to regular March options, I would position by selling the March $93 calls and buying the March $96 calls for a 60-cent net credit. Breakeven is at $93.60, 5.2% above the closing price of $88.82 and at the key overhead resistance area from early November.
The maximum gain on the trade is $60 per spread, with the maximum risk of $240 per spread. Return on risk is 25%.
I would close out the trade on a meaningful break of the $94 resistance level, while looking to have the spread expire worthless and retain the initial $60 credit if CVX remains well-behaved.
Oil Stocks: Schlumberger Limited (SLB)
Click to Enlarge Schlumberger (SLB) has mirrored the rally in CVX since the recent highs of oil on Jan. 29, rising nearly 3%.
SLB is more of an oil service stock than either XOM or CVX, but the correlation to oil is of a very similar nature. Again, I look for this latest period of dramatic outperformace to revert back to the mean, with Schlumberger being a relative underperformer to the price of crude.
SLB is overbought on a 9-day RSI basis with a reading of 70.87, with implied volatility at the lowest levels of the year, highlighting the level of complacency. This combination of overbought and overcomplacent has been a solid precursor for short-term tops.
Once again looking out to regular March options, I would position by selling the March $77.50 calls and buying the March $80 calls for a 50-cent net credit. Breakeven is at $78, providing a 4.88% cushion versus the closing price $74.37 and below resistance at $76.73 from the gap last August.
The maximum gain on the trade is $50 per spread, with the maximum risk of $200 per spread. Return on risk is 25%.
I would close out the trade on a meaningful break of the $76.73 resistance level, while looking to have the spread expire worthless and retain the initial $60 credit if CVX remains well-behaved.
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.
