Ever since the blow-off top in energy stocks earlier this month, we’ve seen nothing but bearish action out of the Energy Sector SPDR (NYSEARCA:XLE). The misbehavior came to a head Wednesday when XLE slipped below its 50-day moving average. While it could be a fakeout, the signal has me eyeing short trades in the sector just in case it’s a sign of things to come.
The rollover in energy stocks speaks to a broader theme playing out this month where small-caps have started to diverge once more from the rest of the market. It’s a concerning development because it reveals a narrowing to the recovery where fewer and fewer stocks are trying to pull the market higher. The uptrend is healthiest when all equities are pushing higher, not just a handful of mega-cap tech titans.
If you’re shopping for short candidates, then here are three tickers to consider:
- Exxon Mobil (NYSE:XOM)
- Valero Energy (NYSE:VLO)
- SPDR S&P Oil & Gas Exploration and Production ETF (NYSEARCA:XOP)
Let’s take a closer look at which options strategies to use if the energy rollover continues.
Energy Stocks Rolling Over: Exxon Mobil (XOM)
As the largest holding of XLE, Exxon Mobil was an obvious choice. Its price action has mirrored that of the sector, slipping below the 50-day moving average on heavy volume yesterday. We’ve seen a handful of distribution days over the past three weeks, suggesting yesterday wasn’t an isolated incident. Until this trend reverses, you have to view rallies in XOM stock with skepticism.
The next support level lies at $40, so that’s my first target. It’s more than 10% away, leaving plenty of room for profits if bears press their advantage. Put spreads offer a more compelling risk-reward than long puts, so that’s my preferred play here.
The Trade: Buy the Aug $45/$40 put spread for $2.
The original $2 cost is the max loss and will be forfeited if XOM stock sits above $45 at expiration. The max gain is $3 and will be captured if the stock falls below $40 by expiration.
Valero Energy (VLO)
In surveying the most liquid energy stocks, I discovered Valero Energy had one of the most ominous-looking support breaks. At Wednesday’s close, it had already fallen 25% off its recovery high. Distribution days are multiplying, and yesterday’s breach of the 50-day was particularly ugly.
What’s more, even though the energy sector is sitting well in the green this morning, VLO stock is down nearly 2%. The relative weakness is signaling to bears to come and play. I think a push to $50 could be in the cards. At 35%, the implied volatility rank is high enough to make spreads less risky than purchasing options outright. We’re going to follow in the path of XOM and go with another bear put.
The Trade: Buy the Aug $55/$50 put spread for $2.
The risk-reward mirrors that of Exxon’s trade. By risking $2 to make $3, the spread offers a potential 150% return on investment.
SPDR S&P Oil & Gas Exploration and Production ETF (XOP)
Our final pick offers a more diversified choice than its predecessors since its an exchange-traded fund not just a stock. But because it’s not heavily weighted in a few large-caps like XLE, it has more volatility if you’re looking for a higher-octane trade. XOP tumbled 7.2% on Wednesday, breaking both a horizontal support zone and its 50-day moving average.
The next support pivot sits at $45, which is about 12% away. While we may not see a straight shot lower without a retracement, it is a realistic target for a multi-week trade. To mix up the strategy selection as well as offer a more aggressive idea, we’re going with long puts. The implied volatility rank of XOP is at 22%, making it lower than the previous two tickers.
The Trade: Buy the Aug $50 puts for $4.40.
Your risk is capped at $4.40, and the reward is open-ended.
For a free trial to the best trading community on the planet and Tyler’s current home, click here! As of this writing, Tyler held neutral options positions in XOM.