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Big Oil Is Long Overdue for a Big-Time Rally

Buying an inexpensive call diagonal to play for a pop in XLE

By Tim Biggam, InvestorPlace Contributor


Shares of Energy Select Sector SPDR (ETF) (NYSEARCA:XLE) finally are beginning to show some life after languishing over the past month.

XLE, which is comprised of the biggest oil names like Exxon Mobil Corporation (NYSE:XOM), is down 7.5% year to date while the S&P 500 is showing a 1.5% gain so far in 2018. More significant is the fact that crude oil has put in a 6% rally since the beginning of the year while oil stocks have fallen sharply.

I look for this divergence to begin to converge and XLE to be a relative out-performer in the coming weeks.

On a technical, basis, $67 is the key level to watch. XLE has spent the past month building a base around this inflection point. The chart also highlights the recent wide divergence between the XLE ETF and the price of crude oil.

Normally, highly correlated to oil prices, oil stocks are now trading at the cheapest price to crude oil over the past year. If history is any guide, this spread will need to begin to narrow dramatically, meaning oil stocks will start to head higher.


Interesting to note that in the latest Earnings Insight piece by FactSet , the energy sector had the largest increase in expected earnings since the start of the quarter. XOM, in particular, was strong, with an earnings bump from $1.02 to $1.16.

Even following the increased earnings expectations, shares of Exxon fell over 10%. Call me old-fashioned, but I like the combination of better earnings and lower stock prices-a dual benefit for lower P/E ratios and more attractive valuations.

The chart below shows XOM — the largest component in the XLE — now trading at by far the cheapest P/E multiple over the past two years.

In my Options Insight appearance yesterday on Bloomberg TV, I discussed the overall market and oil stocks in particular and went over my XLE trade.

XLE Options Trade

Buy XLE Apr $67 calls and sell XLE Apr 6 $68 calls for a 95 cents net debit.

Maximum loss on the trade is the debit paid of $95 per spread. Ideally XLE closes near $68 on the April 6 weekly expiration date of the $68 calls that were sold, thus realizing the maximum potential profit.

Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility/.

Article printed from InvestorPlace Media, https://investorplace.com/2018/03/big-oil-xle-is-long-overdue-for-a-big-time-rally/.

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