Breakout trades are part and parcel to a technician’s toolbox. However, not all breakouts are created equal. Some set up quite sloppily, providing a poor risk-reward and diminished odds of success. Others form at pivotal resistance levels, providing an appealing risk-reward and an elevated probability of profit. The appeal of a breakout is more easily understood when one considers the underlying dynamics behind the pattern.
Click to Enlarge Take the current setup in king of the oil patch, Exxon Mobil (NYSE:XOM), for instance. During the past two years, each and every uptrend was halted by the $88 level, which has acted as an impenetrable ceiling — an area where the bears have congregated en masse, flooding the market with supply.
Yet with each renewed attempt at breaching $88, a portion of the sellers at that level are removed from the market. This means, of course, the more times this resistance is tested, the higher the likelihood it eventually fails. Lucky for XOM bulls, the failure of $88 should result in rapid follow-through to the upside like water finally bursting through a weakened dam.
If and when $88 succumbs to the buying pressure, bullish plays ought to be considered to exploit a continued advance in XOM. With options implied volatility sitting at a paltry 15%, option prices appear on the cheaper side of the value coin. As such, option buying strategies might be the way to go.
Traders could enter a Sept 87.50-90 bull call spread by buying the 87.50 call and selling the 90 call. Currently the spread is trading for around 95 cents. At this price, the max risk is limited to $95 (0.95 x 100) and will be incurred if XOM sits below $87.50 at expiration. The max reward is limited to the distance between strikes ($2.50) minus the initial 95-cent debit paid at trade entry. This $1.55 reward can be captured if XOM rises above $90 by September expiration.
Those not wanting to take the anticipatory entry ought to wait for XOM to break above $88 before pulling the trigger on the call spread.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
