Shares of Valero Energy Corporation (NYSE: VLO) have been on quite a tear over the past few months. VLO stock is now up over 40% since making a low of $86.77 in early February. As a leading energy refiner, much of that gain is tied to the big-time rally in oil. Now that oil is looking topped out after a major move higher, I look for oil stocks like Valero to follow suit and pull back over the coming weeks.
Valero is certainly not a pricey stock on an absolute basis, trading at only a 12.6 current P/E. Yet when compared to the historical averages, VLO is getting comparatively expensive. The current P/E is well above the five-year average of 10.1. Other metrics, such as Price/Book, Price/Sales and Price/Cash flow are also well above the norm.
Valuations almost invariably revert to the mean, signaling lower prices ahead for VLO stock.
VLO stock is definitely looking overextended from a technical perspective. The 9-day RSI saw extreme readings over 80 before finally weakening. Previous instances when 9-day RSI exceeded 80 proved to mark significant short-term tops in VLO stock. Shares are also trading at the largest premium to the 100-day moving average over the past year. The prior time Valero traded at such a wide differential lead to a sharp pullback to the moving average line.
Most importantly, VLO stock had a key reversal day yesterday. Shares traded at a new all-time high at $122.68 intraday before reversing course to close near the lows of the day at $120.15. This type of price action, especially following such a big rally, is usually emblematic of a short term top in the stock. The buyers may finally be exhausted after such a extended run and a pullback could be on the horizon.
Implied volatility (IV) in VLO options is trading near the lowest levels over the past several months, meaning option prices are cheap. This favors long volatility strategies when constructing trades.
So to position for a pullback in Valero, a put diagonal spread makes intuitive sense.
VLO Stock Trade Idea
Buy VLO July $120 puts and sell VLO June $115 puts for a $3.20 net debit.
Maximum risk on the trade is $320 per spread. Ideally VLO stock closes near $115 at June expiration. The trade is 23 deltas net short at inception-the equivalent of being short 23 shares of Valero.
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.
