Well what have we here? Is that strength in energy stocks I see!? As someone who has been selling puts in the space for the entire year, can I just say it’s about time? In case you missed it the Energy Select Sector SPDR (ETF) (NYSEARCA:XLE) popped 1.46% Wednesday on heavy volume. Looks like the luck for XLE bottom-fishers may be about to change.
By the way, the high-volume hop in XLE was accompanied by an even more impressive rally in SPDR S&P Oil & Gas Explore & Prod. (ETF) (NYSEARCA:XOP) and Vaneck Vectors Oil Services ETF (OIH). Together, these three oil-related ETFs bested the performance of every other sector yesterday.
To chronicle the turnabout in energy stocks, let’s begin with a weekly look at XLE.
XLE Weekly Stock Chart
The weekly trend has pointed lower for all of 2017. Its consistency has been uncanny, particularly considering the bullish undercurrent to the broader stock market. The energy sector has been one of the only areas where bears have yet to relinquish control.
But, as mentioned, it looks like their grip is slipping.
This year’s drop has carried XLE to its 50% retracement zone. That is, the fund has given back half of the gains acquired during last year’s rousing recovery. As Fibonacci fanatics will attest, the 50% retracement level sits squarely in the buy zone for spectators looking to buy dips. So this is as good an area as any for bulls to step up and wrest back control.
The $64 level has also acted as support and resistance multiple times in the past so there’s definitely some price memory here.
XLE Daily Stock Chart
As we move to the daily chart, the improvements in XLE’s technical posture begin to add up.
First came the slowing momentum. Though the fund fell to a new marginal low during its last downswing (July 7th), the RSI indicator developed a higher swing low. This created a bullish divergence signal.
What’s more, the Relative Strength Index (RSI) is now perched at its highest level for the year (56) and is oh-so-close to rising further than any other rally of 2017.
Next up is the sharp rejection of yesterday’s rollover. If XLE were following its usual playbook, Tuesday’s reversal candle would have continued lower. But it didn’t. Yesterday’s ascension formed a bullish engulfing candle which fully enveloped the prior candle’s body.
Then there’s the current probing of the 50-day moving average. Though we saw a similar test in April that failed, I suspect this time the breakout bid will succeed.
Fellow energy fund OIH has already popped above its 50-day. And with Wednesday’s rotation into small-caps (the Russell 2000 broke out) we’re finally seeing rotation into underperforming areas. That should bode well for XLE.
Finally, the volume yesterday was substantial. Remember: High-volume days add legitimacy to price moves and suggest institutions wading into the waters.
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Here’s the bottom line: XLE bullish trades are worth a shot here.
Option values in XLE aren’t as pumped as they once were so I’m thinking we go with a long premium play. Buy the Aug $65/$68 call spread for $1.39. The spread consists of buying the Aug $65 call while selling the Aug $68 call. The initial cost of $1.39 represents the max loss and will be forfeited if the fund sits below $65 at expiration.
If you’d prefer to jump ship at the first sign of trouble, then close the trade if XLE falls below $64.
The max gain is $1.61 and will be captured if XLE can rise above $68 by expiration.
As of this writing, Tyler Craig held neutral option positions in the Russell 2000 Index. Want to learn how to master the art of option selling for high-probability cash flow? Check out Tyler’s recently released video series through Tackle Trading on how to systematically sell iron condors for monthly income.