New Trade Alert for (XLE)
Energy Select Sector SPDR Buy XLE March $57 Call @$7.00 or less
Risk Rating: 3.5 (1 = lowest 5 = highest)
Above Break Even Probability: 45%
Max Loss Probability: 29%
The BOTTOM is N E A R…has been yelled from the mountain tops for months. Oversold markets like OIL can get always more oversold with financial and emotional pressures unrelenting.
Crude marked new multi year lows this week AND closed higher to signal the beginning of a base bounce. A weekly close above $35.60 is needed for a weekly KEY reversal technical turn.
Interestingly, the XLE Energy exchange traded fund DID NOT make new lows on the latest Crude slide. The August, September and December support has held above $58 in XLE.
Divergence in this basket of energy stocks can be attributed to big boys like Exxon and Chevron, make up 30% of XLE weight, not venturing even close to year lows.
The XLE range is stuck from $60 to $64 in the last weeks targeting $68 on an upside rush. The next objective is $71 which represents the 52 week midpoint resistance.
The risk to reward favors a bull bias after the epic energy collapse. The overwhelming negative sentiment can be a contrarian signal to be a buyer.
A stock substitution strategy using options ties up less capital and has absolutely limited risk to the premium paid. An option instead of buying the shares also has greater staying power for long term trend development.
The March option has three months plus for Bullish development.
An In-The-Money option gives you the right to be long the shares from a lower strike price and costs much less than the stock itself.
The Options Way: Unlimited Upside Potential with Limited Risk.
An XLE long call option can provide the staying power in a potential bullish trend extension. More importantly, the maximum risk is the premium paid.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.
Choosing an option can sometimes be a daunting task with all of the choices and expiration months. Simply put, traders want to buy a high probability option that has enough time to be right.
The option strike price is the level at which you have the right to buy without any obligation to do so. In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for gain or loss.
There are two rules options traders need to follow to be successful.
Rule One: Choose an option with 70%-plus probability. The Delta is a measurement of how well the option reacts to movement in the underlying security. It is also important to buy options that payoff from only a modest price move.
There is no need to ONLY make money on the all but infrequent long shot price explosions.
Good Options can profit from only modest directional moves.
Any trade has a fifty/fifty chance of success. Buying options ITM options increase that probability. That Delta also approximates the odds that the option will be In The Money at expiration.
Buying better options are more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long shot Out Of The Money lottery tickets that rarely ever pay off.
With XLE trading at $62.50, for example, an In The Money $57.00 strike option currently has $5.50 in real or intrinsic value. The remainder of any premium is the time value of the option.
Rule Two: Buy more time until expiration than you may need — at least three to six months for the trade to develop. Time is an investor’s greatest asset when you have completely limited the exposure risks.
Traders often buy too little time for the trade to develop. Nothing is more frustrating than being right but only after the option has expired premature to the market move.
Trade Setup: I recommend the XLE March $57.00 Call at $7.00 or less. A close in the stock below $58 on a weekly basis or the loss of half of the option premium would trigger an exit.
An option play also has staying power with the ability to ride through Ups and Downs that would force most stock traders out of the position.
The option also behaves much like the underlying stock with a much less money tied up in the investment. The Delta on the $57.00 strike call is 75%.
The March option has more than three months plus for bullish development. This option is like being long the stock from $57.00 with completely limited risk.
XLE has not been below $58 since 2011 more than four years ago.
The maximum loss is limited to the $700 or less paid per option contract, with a stop loss exit at half of that premium. The upside, on the other hand, is unlimited.
The XLE option trade break even is $64.00 or less at expiration ($57.00 strike plus $7.00 or less option premium). That stands $1.50 above the current price.
If shares hit the $71 midpoint price of the $84 drop to the $59 lows, the option would be worth $14.00 for a 100% return on investment.