After months of dribbling lower, energy stocks are finally putting up a fight. It’s a welcome change of pace for a sector that’s been so wholly abandoned by the Street. If you’re a contrarian, the turnabout seems to have arrived right on schedule. Max pessimism was achieved, and thus, a reversal was ripe.
The speed of the resurrection caught many by surprise. After the initial vaccine-inspired surge, energy never really looked back. The unwillingness to pause or pull back essentially required spectators to chase or get left behind.
Until now, that is. On Tuesday, the sector formed its fourth straight session of closing lower than the open. With that, we have our first legitimate pullback of the new uptrend. If you’re a true believer in the turnaround, then this dip is a rousing buy. I’ve inspected a variety of energy-related ETFs and stocks to discover the best setups.
Here they are.
- Energy Sector (NYSEARCA:XLE)
- Chevron (NYSE:CVX)
- Oil & Gas Exploration & Production ETF (NYSEARCA:XOP)
Their charts speak for themselves, but I’ll add some context and a trade idea to expand on the bullish thesis.
3 Ways to Play Energy Stocks’ Revival: Energy Sector (XLE)
Some traders overlook the obvious. Before fiddling with which component offers the most attractive risk versus reward, or perhaps which company boasts the best fundamentals, the simplest way to game the energy comeback is to buy the entire sector. There’s no idiosyncratic risk nor earnings reports to worry about.
XLE is the indisputable champion when it comes to popularity and liquidity. It’s heavily weighted toward large-caps, with Exxon Mobil (NYSE:XOM) and Chevron accounting for over 40% of the fund. And for some traders, that can cause issues.
“The problem with the XLE index is that a few large-cap gas and oil firms can quickly affect it,” wrote Laura Gonzalez, Ph.D., associate professor of Finance at California State University, Long Beach, in an email to InvestorPlace. “This leads to volatility, which is something some investors with knowledge of the industry prefer.”
But in a year where small-caps have been destroyed, owning a fund heavily weighted toward the big boys helped. XLE is now above all major moving averages and has bullish volume patterns to boot.
It’s impossible not to view this week’s retreat as an opportunity.
The Trade: Buy the Jan $37/$42 bull call spread for around $1.40.
If you’d rather play an individual stock, but want to steer clear of the small-cap riffraff, then Chevron is your best bet. Its share price has held up far better than Exxon Mobil. From October’s low of $65.15, we’ve seen prices rebound by nearly 50% before this week’s pullback. Along the way, we rose above every moving average. This is the first rally of the year that was able to carry past the 200-day, so I think it’s a trend worth betting on.
And speaking of the 200-day, that’s the next potential support zone that buyers are likely to defend if the selling keeps up for another session or two. Implied volatility is too low to get excited about selling premium. Instead, we will go with a directional call spread.
The Trade: Buy the Jan $90/$95 bull call spread for approximately $1.70
If you want confirmation that the next upswing is beginning, then wait for a break of the prior day’s high before entering.
Oil & Gas Exploration and Production ETF (XOP)
Our final candidate provides a higher-beta play for gaming energy stock’s new bull market. It has followed in the footsteps of CVX and XLE by blasting through multiple resistance zones last month. Momentum and volume both increased during the rise, providing evidence that the nascent trend has staying power.
While we could see a few more days of profit-taking, multiple support levels loom close. In particular, the 20-day and 200-day moving average marks spots where I’d be interested in deploying trades.
Because of XOP’s generally high level of volatility, short puts offer a tasty payout.
If you’re willing to bet the fund remains above $45 for the next month, then here’s your trade.
The Trade: Sell the Jan $45 puts for $1.20.
On the date of publication, Tyler Craig did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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