With oil prices seemingly looking to stabilize around the $40 level, shares of the major oil players such as Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX) and ConocoPhillips NYSE:COP) are starting to look attractive again.
While not looking for a rip-roaring rally to the upside, I think most of the intermediate-term carnage has been seen in the Big Oil stocks.
Click to Enlarge The major oil stocks are highly correlated to crude prices, which certainly makes sense. Crude prices look like they may have found some footing at the major support level of $39 following the recent drubbing, which should translate to support for the Big Oil players.
XOM is the largest market cap U.S. oil stock and can be used as a proxy for the overall sector. The XOM chart, with oil prices overlaid, is interesting for two reasons.
First, it shows how oversold shares of Exxon had become. with a 14-day RSI reading well below the 30 level.
Second, it indicates that the comparative premium to oil prices evidenced when XOM traded at its high of $95.55 has been rectified, with Exxon now back to fairly valued in relation to oil.
Click to Enlarge The CBOE Crude Oil Volatility Index is at recent highs, showing heightened levels of concern in the options market. Previous instances when the OVX spiked proved to be opportune times to take a long position in crude oil.
So with both oil and oil stocks looking oversold, and with signs of bottoming, what is the best way to play for a stabilization in oil? Certainly, you could use the big oil names like XOM, CVX, and COP. Or go long some oil futures. Both of these methods carry a fair amount of risk.
For more risk adverse traders, using the Energy Select Sector SPDR (ETF) (NYSEARCA:XLE) is a more prudent approach. The XLE provides some diversification to temper risk, while also providing exposure to the Big Oil stock names. Exxon and Chevron comprise nearly a third of the weighting in the XLE.
Click to Enlarge To further dampen risk, a defined risk, put credit spread strategy on the XLE makes sense to me.
Buy XLE August $61 puts and sell the XLE Aug $63 puts for a 20 cents net credit. The maximum gain on the trade is $20 per spread, with a maximum risk of $180 per spread. Return on risk is 11%.
The short strike is 4.2% below the current $65.75 closing price of XLE.
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.
