After bottoming out at the $62 area, shares of Energy Select Sector SPDR (ETF) (NYSEARCA:XLE) rallied for six straight days until final pulling back on Friday. The 4% rally was overdue, given the sharp selloff in XLE shares. Although it appears to have put in an intermediate low at the $62 area, I also think that XLE will have trouble moving significantly higher over the coming month.
XLE is comprised of the major players in the energy sector, with four stocks Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX), Schlumberger Limited (NYSE:SLB) and ConocoPhillips (NYSE:COP) accounting for over 50% of the ETF weighting.
Click to Enlarge The one-two punch of Hurricanes Harvey and Irma will likely have a lingering negative effect on energy production in the Gulf region over the short term. This should provide a headwind for further price appreciation in the major energy names. As goes these four stocks, so pretty much goes the XLE ETF.
Shares of the XLE ETF are also correlated to the price of oil. Goldman Sachs just lowered GDP by nearly 1% for the next quarter due to the Hurricane effect. Slower growth leads to lower oil consumption and diminished demand. This should add to the over supply concerns that still continue to plague the oil market.
From a technical perspective, shares of XLE have major overhead resistance at the $66.25 level. Two failed breakouts (highlighted on the chart) help to reinforce that resistance. XLE was also extremely overbought on a nine-day RSI basis with a reading over 70 before the reversal on Friday.
The only other reading above the 70 level over the past year marked a significant top in shares of XLE. Friday’s price action, which was a price reversal, also confirmed the notion that XLE will likely struggle over the next several weeks.
So given the continued fundamental overhang in oil and the overbought technical environment in XLE, selling an out of the money call spread makes intuitive sense.
XLE Trade
Buy the XLE Oct $68 calls and sell the XLE Oct $66 calls for a 30 cents net credit.
Maximum gain is $30 per spread with a maximum risk of $170 per spread. Return on risk is 17.64%. The breakeven point of $66.25 coincides with the major resistance level.
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 timbiggam@gmail.com.
