Tuesday, February 3, 2015

XOP: Bull play, shorter-term rules

Update 5/8/2015: XOP fell toward unprofitability with a month to go before expiration. It's a long position, subject to time decay, so I exited to avoid the potential loss.

Shares rose 1.1% over 94 days, or a +4% annual rate. The options position was a wash -- no loss, but no profit.

Update 2/3/2015: I've opened the position, with a variation on what was described below. I widened the spread to long the $51 calls and short the $53 calls. This enabled me to lower the number of contracts required, making the fill easier and slightly lower my fees.

The SPDR S&P Oil & Gas Exploration and Production exchange-traded fund (XOP) broke above its 20-day price channel on Monday and continued with a further sharp rise today, confirming the bull signal. [Oil and gas exploration in Wikipedia]

The price reversal coincides with a similar pattern in crude oil prices, the life's blood of the industry.

The Charts

Looking first to the right-hand chart for XOP and applying Elliott wave analysis, XOP's decline from its June 2014 peak counts as five waves ending in December 2014.  The present reversal to the upside from that point is now in its 3rd wave, which I've labeled as wave C.

The five wave pattern in Elliott, traditionally labelled with numbers, is an impulse wave in either an uptrend or a downtrend. "Impulse" means that the movement is the primary trend, and contrary movements are countertrend corrections.

Corrections come in three-wave patterns, traditionally labeled with numbers. Within corrections, C waves are usually quite powerful. However, it is important to remember that it is a counter-trend correction and will eventually return to the primary trend, which is to the downside in this case.

That reversal back to the downside can be expected to fall below the present bottom, $41.63.

The left-hand chart of crude oil futures shows the minuscule nature of the reversal so far, marked with a yellow oval.

In the broad sweep of market history, this is small ball. (See my Jan. 2 essay "The Crude Oil Crash" for a yet broader perspective on crude oil prices.)

Click on chart to enlarge.
Crude oil futures (left) 9 years 1 month monthly bars, XOP (right) 9 months daily bars
Odds and Yields

Since the June 2014 peak XOP has completed two breakouts, a winner and a loser. The winner won big, with a 26.8% gain over 35 days. The loser lost 5.1% over 10 days.

The Fund

XOP's top five holdings, each with less than 2% weight in the fund, are SN, PE, CLR, MTDR and BCEI. The fund in total has 81 symbols in its portfolio.

The fund has a 0.35% expense ratio, compared to 0.9% for the most traded fund, SPY, which tracks the S&P 500. The dividend yield is 1.46%, compared to a 1.76% yield on 10-year U.S. Treasury notes.

Liquidity and Volatility

XOP on average trades 13.4 million shares a day and supports an extremely wide selection of option strike prices spaced 50 cents apart., with open interest running from three to four figures.

The front-month at-the-money bid/ask spread on calls is 6.9%, compared to 0.7% on SPY.

Implied volatility stands at 50%, compared to 19% for the S&P 500 index, and has been declining since mid-January. XOP's volatility is in the 48th percentile of its rise to a high of 63% attained on Dec. 15.

That level of volatility implies that the most profitable trades will be structured as long option spreads, bought with a debit and expiring in June.

Options are pricing in confidence that 68.2% of trades will fall between $43.81 and $58.47 over the next month, for a potential gain or loss of 14.3%, and that 95% will fall between $36.47 and $65.81.

Options are trading briskly today, with calls running at nearly triple of their five-day average volume and puts at 50% above average.

Decision for My Account

I intend to structure the position as a bull call spread, long the $51 call and short the $52 $53 call, bought with a debit and expiring June 20. I'll place the trade shortly before the closing bell if upward momentum continues.

-- Tim Bovee, Portland, Oregon, Feb. 3, 2014


My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my shorter-term trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

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All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.

Based on a work at www.timbovee.com.

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