The oil recovery is gaining steam with crude light rising 10% today. It’s the fifth straight day of gains for the commodity and has traders taking a fresh look at energy stocks to buy. All of this has Chevron (NYSE:CVX) stock catching my eye.
Let’s break down the action in oil and investigate how we can use options to juice our returns with Chevron stock.
Oil Takes Flight
Much has been said about the fiasco that drove crude sub-zero last month. It has been necessary to update my take on the oil charts each time I’ve talked about individual energy companies (see here and here) because the backdrop matters so much to their direction. As we’ve seen in recent weeks, low oil prices kill the profitability of energy companies. And if the prices stay depressed for too long, it can murder the company outright. Just ask Diamond Offshore (NYSE:DO) or Whiting Petroleum (NYSE:WLL).
That fact, more than anything, is why rebounding crude should be celebrated. The fewer companies that kick the bucket, the fewer jobs that will be lost. Ultimately, the return of stability to the energy markets means we have one less issue ailing our already shaky economy.
With today’s gush, crude has returned to the levels it saw when the Saudi Arabia-Russia price war sparked in early-March. The fact that we’ve finally returned is a victory for bulls. I wouldn’t be surprised if we see some supply come into play here though. Unfilled gaps like this have a tendency of turning into resistance. Given the torrid pace of its ascent, however, some consolidation in this area wouldn’t be the worst thing in the world.
Crude’s bullish behavior has kept the recovery in Chevron stock intact. Let’s take a closer look.
Chevron Stock Charts
The weekly chart of CVX shows just how rapid the drop-and-pop has been this year. March’s capitulation gave way to an almost-100% snapback that now has the stock chipping away at resistance near the falling 20-week moving average. Any type of backing and filling in this area is constructive. It will allow Chevron to work through overbought pressures and digest the giant gains.
I view Chevron’s ascent as traders front-running the oil recovery. Over the past three weeks, while oil has been exploding higher, Chevron stock hasn’t budged. In fact, the relationship between them has broken down so much that the 10-day correlation coefficient is hovering near zero. This means they’re not really connected at all. This is likely a short-term phenomenon, and is due to the fact that Chevron’s stock had already risen a ton in anticipation of the recovery we’re seeing in oil right now.
The daily chart is carving out a trading range due to the uptrend’s lost steam. Today’s pop has Chevron sitting in the middle of the range, making it tricky to suggest a directional play. For that, we would need to wait for a breakout over the upper end of the range near $96. But this is where options contracts can help. We can structure a mildly bullish spread trade that will profit from the passage of time. That way, if the stock consolidates for a while before pushing higher, we still win.
Implied volatility has dropped considerably since March, making options premiums much cheaper. We can capitalize by building a call calendar spread. First, we’ll buy a July in-the-money call option to control the stock. Then, we can sell a June out-of-the-money call option against it to reduce the overall cost and capture gains due to time decay.
The Trade: Buy the July $87.50 call and sell the Jun $95 call for a net debit around $6.
The max loss is $6, and the target gain is anywhere between $1 to $2. As long as the stock sits above $90.50, the trade will generate a gain at June expiration.
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