What a difference a day can make — and sometimes not, too. With eyes glued to Vienna’s OPEC meeting this week, Tuesday’s overwhelming narrative was member producers failing to see eye to eye. The storyline spelled certain doom for the energy complex and stocks like CHK and SWN.
Iran and Iraq in particular, appeared to be at odds with the 800-pound gorilla, Saudi Arabia, on cutting output. Barring an unlikely agreement from OPEC members, Saudi Arabia would proceed to dump its massive reserves and crush weaker producers by putting oil on a path towards new decade lows.
Fast forward one day, and surprise! The highly confident consensus view was wrong. A daily production cut of 1.2 million barrels and even cooperation from non-OPEC producer Russia sent the energy complex soaring.
Let the feeding frenzy begin in CHK and SWN? Well … maybe.
First, Chesapeake and Southwestern aren’t pure oil plays. Far from it. Both outfits are key producers and up to their eyeballs in that other fossil fuel known as natural gas. And while the two commodities may move together at times, what drives supply, demand and prices in both can be wildly divergent.
Secondly, pledges from OPEC should probably require asterisk marks. Call me skeptical, but even if all parties were to cooperate, the reduction amounts to roughly 3% from record production levels. In total, forgive me for stating Wednesday’s news doesn’t have that game-changing ring to it.
Given our view, is it any wonder we might have mixed feelings on CHK and SWN? I don’t think so. It also appears other investors may be feeling the same way based on Wednesday’s price reaction in Chesapeake and Southwestern.
Let’s now take a closer look both on and off the price chart at CHK stock and SWN and offer up a couple limited-risk spread ideas to capitalize on some gas in the tank in one and some very “low energy” in the other.
Bullish Trade: Chesapeake Energy (CHK)
Click to Enlarge Chesapeake stock was up nearly 10% Wednesday. Not surprisingly, it wasn’t a standout in the energy complex due to its smaller reliance on the whereabouts of the oil market.
However, the price action courtesy of OPEC served to affirm a fairly supportive-looking uptrend with some gas left in its tank.
The price action in CHK stock is no small feat. Not long ago, Chesapeake Energy appeared to be on the brink of insolvency. In fact, shares were literally drilled into the ground by about 95% from a high near $30 in 2014 to $1.50 this past February as its ability to survive came into question.
The fairly new uptrend in Chesapeake isn’t perfect, as my eyeballed channel lines can attest. That’s OK in our book. I’m a believer that if a chart looks too good to be true, it probably is.
All the same, Chesapeake has put together a series of higher lows and highs which appeals to those seeking classic bullish chart patterns. CHK also successfully tested its 200-day simple moving average and has now broken above its bullishly aligned, institutional 50-day trendline. There appears little in the way of overhead resistance until a test of its recent high near $8. From there, I suspect a challenge of Chesapeake’s upper channel near $9-$9.50 will come into play.
The CHK Feb $8/$9 bull call spread looks attractive here. It’s priced at 22 cents with shares at $7, so Chesapeake needs to rally 17% to breakeven at expiration. If Chesapeake manages to rally 29% or above the sold $9 call strike, the spread trader stands to capture 78 cents or 350% return.
On the surface, the required move for the vertical may sound unreasonable. But given 80 days to expiration, CHK’s obvious ability to rally swiftly and solid reduction in risks associated with its Greeks; the spread does offer a nice blend of risk-to-reward.
You can also adjust the vertical before expiration to create an even stronger position, such as a risk-free trade without CHK needing to hit $9 or maybe not even $8 if the rally occurs sooner rather than later.
Bearish Trade: Southwestern Energy (SWN)
Click to Enlarge SWN stock experienced what President-elect Donald Trump would call very low energy activity on Wednesday. In fact, it was worse as SWN finished down 2% in the face of USO trading up nearly 9%, the Energy Select Sector SPDR (NYSEARCA:XLE) up 5% and UNG bid by 0.6%.
Also not a good sign — SWN put together a bearish engulfing candle on its chart.
The price action in SWN grows more menacing. It confirmed a reversal top within a flag pattern which failed below layers of technical resistance, as well as falling cleanly through both the 50- and 200-day simple moving averages. Looking forward, I’d expect SWN will trade lower from here. Based on the evidence, an initial price target of $9 to challenge recent lows seems doable.
The SWN Jan $11/$10 bear put spread is interesting. The trade is priced for 40 cents with shares at $11.35, and the vertical buyer can turn a profit of 60 cents or 150% if SWN can drop 12% into expiration.
Similar to CHK, if SWN shares move in the intended direction sooner rather than later and closer to expiration, traders might consider adjusting into an even sturdier risk-to-reward position.
Lastly and in this instance, I’d also be flexible with this SWN vertical. Use a trailing 50% stop-loss to exit in the event that Wednesday’s good-looking bearish setup is too good to be true.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.