While energy prices have yo-yoed up and down, the Energy Select Sector SPDR (ETF) (NYSEARCA:XLE) has been in a consistent slide. Crude oil prices have been range-bound keeping a stifling downward pressure on the industry. When crude prices rise above $53 it’s bad for OPEC’s market share and below $45 it’s bad for their pocketbooks. Somewhere in the middle lies the happy equilibrium. Hence, the range.
The ideal way to trade this using options would be to sell iron condors against the range. However, I have refrained from shorting oil rallies because OPEC members have been masters of talking up price. That’s a risk that I don’t need.
Instead, I have sold downside risk against elevated levels of fear when they occur, much like this recent dip. Too many experts expect crude oil to fall below $40 again, but I fundamentally don’t think this will happen.
Click to Enlarge Technically speaking, it’s never easy to catch a falling knife, especially in the XLE ETF, which is heavily affected by rhetoric. Furthermore, I have to account for its largest components and their individual circumstances.
Mainly Exxon Mobil Corporation (NYSE:XOM), which is about a quarter of the XLE ETF. Exxon is currently technically vulnerable to another 5% to 7% drop.
The Thesis: I bet that crude is near a bottom, so I am willing to own XLE if energy falls another 10% from today’s levels. So far, the slide has been inside a descending channel that started mid-December. But now prices are bumping atop a pivotal level that has served as support since April of 2016. If markets in general hold up, XLE will find footing soon.
The Trade: Sell XLE Sept $60 naked put and collect $1 per contact. This is a bullish trade that needs price to stay above my strike. Otherwise, I own the shares and would suffer losses below $59.
Notice that my trade structure doesn’t need a rally in energy to win. I merely need prices to find footing with plenty of room for error. Selling naked puts is dangerous, but I could mitigate some of the risk by using spreads instead.
The Alternate: Sell XLE $60/$59 bull put spread where I have about the same level of success, but limited risk. Yet, the spread still can yield 20%. Compare this with buying the XLE and risking almost $66 here and then needing it to rally 20% just to match the performance of the spread.
That said, selling options is risky business, so I only risk money that I am willing to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
