Energy traders are often on the wrong side of the correct oil trade. The fundamentals are not tricky, but media pundits cause noise that confuses people. Global oil demand has not changed in a long while, yet the experts still insist on forecasting explosive oil prices. So far they have been wrong and the proof is in the failed spike reactions to headlines. They have not held up for more than a few hours. Not even when drones struck the Saudi oil fields or more recently when the U.S. and Iran clashed.
Simply stated, the fundamentals for trading energy stocks are simple. When crude oil nears $60 per share it encounters strong resistance. So it would not be an obvious entry point into energy stocks like the ones we discuss today. Conversely when rhetoric flips overly negative and the experts become overly bearish, then it would be time to go long.
It is important to establish the range-bound thesis for oil. Because it directly impacts energy stocks like Chevron (NYSE:CVX), Exxon Mobile (NYSE:XOM) and the Energy Select Sector SPDR Fund (NYSEARCA:XLE). Understanding the range for oil makes it easier to better time the trades in CVX, XOM or the XLE exchange-traded fund.
They have traded in a see-saw pattern and since my last write up in November, they rallied 6% and fell 8%, thereby confirming that they are better trading vehicles than investments in this environment. Chevron and Exxon make up for almost 40% of the entire ETF. So it would make little sense to bet on all three stocks at the same time.
Energy Stocks to Trade After the Turmoil: Energy Select Sector SPDR Fund (XLE)
XLE stock has been choppy so it has strong rallies, but stays inside ranges. So every spike is followed by a correction. The trick is to pinpoint favorable entry points. This is not the same as saying that investors need to be perfect, no one should expect this. But it is easy to identify a viable range to trade and time the plateaus and troughs.
For five years, the XLE has held a support zone. Investors bought every dip when it neared $56 per share. So, as long as equity markets in general don’t correct, I expect this to happen again. If my thesis is correct, then from $57.50 the XLE has more upside potential than downside risk. The idea is to buy it as it approaches $57 per share and expect a bounce back up to $60, which would be the target exit point.
The XLE recently triggered a bearish pattern once it lost $59 per share. It is near the measured target move from it, but this is not an absolute line in the sand. Meaning the goal is to find the trough and not the absolute bottom. No one is that good or lucky all the time. Since we’ve noted that this would be a trade, then by definition it should have a stop loss. It makes for good practice to choose a value that nullifies the thesis for the trade. In this case, if the XLE breaks support it would render my assumption inaccurate and the trade should be closed.
As confident as I am in the overall limit to oil prices, I know that if there are winners among energy stocks it would be CVX or XOM. So this thought extends to both of them. They are not cheap since they both sell around price-to-earnings ratios of 18. This is just below high tech growth stocks like Apple (NASDAQ:AAPL) to name one. But that is not likely to be a major issue in the long term. Here too Wall Street will buy the dips when they become extreme.
For CVX there is support at $110, $105 and $100. The lowest of which came under the drubbing of Christmas of 2018 when investor sentiment was the worst in decades. It will be unusual for CVX stock to lose $100 under this set of macroeconomic conditions. Buying it as it nears $110 per share would offer the opportunity for a bounce back towards $120 per share. But there is also the method of using options to benefit from these beastly companies.
An alternative to risking $112 and buying shares here, is to sell the Dec $90 CVX puts. This way, you collect $2.5 per contract, which would be the maximum gain. Ideally, CVX stays above $90 per share this year for full profit. This creates a 20% buffer from current prices and does not require a rally to win. The first actual loss would not occur until the stock falls below $87.50 per share.
Exxon Mobil (XOM)
XOM stock has similar characteristics as CVX, so the same logic applies. I can buy it as it nears $65 per share and hope for a rally to $72, but there first needs to be a trigger. There is a difference in how the stock has behaved in the last five years. Unlike CVX, XOM doesn’t have a pivot zone. It has traced lower highs as it keeps testing the support. This brings it into a point with a lot of energy. So from a trading perspective the rebound here will look more like a descending wedge breakout and could have more upside potential. But this also makes the floor less reliable in the short term.
The strategy would be the same here too until the breakout is confirmed. Meaning, I can start the trade by selling the puts in XOM for income, then add the upside chase with call options or stock purchase. The put option trade would be to sell the Sep $55 put to collect $1.5 for the risk. This trade wins without needing a rally and also has an 18% buffer from current prices. The trader won’t own the shares and accrue until XOM falls below $53.50 per share.