After bottoming out around the $60 level on Sept. 29, shares of the Energy SPDR () — which is comprised of the top oil stock names like Exxon Mobil Corporation () and Chevron Corporation () — have been on a major bull run, moving up nearly 15% over the past eight trading sessions. This easily outpaced the gain in crude oil prices during the same period (10%), as oil prices briefly hit the $50 level on Friday before retreating.
Shares of XLE finally showed some weakness on Friday, though, closing lower by 45 cents after trading higher earlier in the session.
From a technical standpoint, however, XLE is getting into overbought territory, with 9-day Relative Strength Index readings over 70 for only the third time over the past two years.
Click to Enlarge The prior two instances marked very opportune times to take a short position in XLE, as seen in the chart.
Shares of XLE also stormed past the 50-day moving average of $65.15, and are currently trading above this average by 5.82%. The prior two market tops saw the 50-day MA exceeded by only 5.63% and 4.91%, respectively, before shares began to pull back , so XLE definitely is getting a little frothy from a price action standpoint.
Fundamentally, the weaker dollar and concerns out of Syria have provided a short-term positive backdrop for oil stocks, but longer-term, oversupply concerns still are still the predominant theme.
Canadian oil production is expected to
, with Alberta oil sands projects being the largest contributor. The Energy Informatiion Administration said Wednesday that oil inventories in the U.S. , versus expectations of only a 2.55 million-barrel increase. The Department of Energy reported that , as compared to analyst estimates of 9.1 million.
Implied volatility, which is a measure of option pricing, has dropped sharply owing to the recent rally, which is also a contrarian bearish signal. It also makes long option strategies more attractive, setting up a straightforward put purchase as an effective way to play a pullback in the XLE.
To take a guarded short position in oil stocks, I would buy the XLE Dec $69 puts for $3.20 or better. This is a defined-risk trade, with the maximum loss being the initial option premium of $3.20. I would use a move back toward the 50-day moving average level of $65 as my first profit objective, with a secondary objective at the recent lows of $59.50.
From a risk management standpoint, I would look to exit a portion of the position if the anticipated pullback in oil stocks fails to materialize by November expiration.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities.
