After rallying nearly 18% from the Jan. 20 low of $71.55, Exxon Mobil Corporation (XOM) stock has been consolidating in the $82-to-$86 range in front of earnings on April 29. Whether it breaks down (bearish) or breaks out (bullish) after that event is anyone’s guess, but a cheap straddle play can position for a move in either direction.
Click to Enlarge As seen in the chart, Exxon Mobil is at a critical juncture. Major overhead resistance is looming at the $87 level, which previously was support.
Since making an all-time high of $104.76 on July 29, 2014, XOM stock has also made a series of lower highs.
If XOM stock can break out convincingly above the $87.44 high from Nov. 3 of last year, not only will resistance be broken but the downtrend will be broken as well. A failure to move through the $87 level could lead to a sharp pullback.
Click to Enlarge Exxon Mobil, normally correlated to crude, has recently deviated sharply from the price of oil. XOM is now trading at the biggest comparative premium to crude oil over the past year. At some point, stretched correlations invariably realign, many times in a violent fashion.
Yesterday’s price action in XOM showed a bullish engulfing pattern, with XOM stock opening sharply lower at $83.89 only to immediately turn and rally to close nearly on the high of the day at $85.78. This type of reversal pattern can many times signify and impending breakout in the stock.
Click to Enlarge While both a bullish and bearish case can be made for XOM, the one thing known for sure is that option prices are at the cheapest level seen since last July. Even with earnings looming on April 29, implied volatility is only in the 18th percentile.
The potentially combustible combination of:
- Consolidating stock;
- Key technical inflection point;
- Cheap options; and
- Earnings due
sets up very nicely for a straddle play.
XOM Stock Options Play
Specifically, with XOM trading around $86, I would look to buy the XOM April 29 $86 calls and XOM April 29 $86 puts for a $2.20 net debit.
These options expire the same day as earnings (which are due before the open). This is an aggressive play, with greater risk and reward than a non-earnings-related play, so position size should be lowered.
It is likely that the position will be held until expiration with the maximum loss of $220 per straddle realized if XOM closed exactly at the $86 strike price. Upside breakeven at expiration is $88.20 while downside breakeven is $83.80. This means XOM needs only a 2.6% move to break even.
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 firstname.lastname@example.org.
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