Taking a Stab at Oil (XOM,USO,HD)

We’re in the middle of a bounce.

 

We don’t know how long or how high it will carry, so until we see genuine technical signs of a continued bull, we have to be guarded.

 

That said, we bulls still have a few key indicators on our side.

 

The first is sentiment, which is dreadful. No one is happy, the world looks increasingly dangerous, protest candidates are surging, and the last thing on the minds of Main Street investors is shoveling more of their savings into equities.

 

Fair enough. We track AAII sentiment numbers precisely for moments like these. We’re now in the pit of sentiment hell. It can’t get any worse.

 

And that’s a plus from a contrarian standpoint. Simply put, it means nearly everyone who wants to sell has already done so and is expecting calamity. And that’s precisely the point at which the smart money buys.

S&P 500

But what if it’s just a temporary bounce that fizzles?

 

Then so be it. We’ll see what happens to sentiment as the indexes do advance. If they remain painfully pessimistic, we’ll remain chuckle-dee-do.

 

Another Plus

 

Consider also, the market has done little to nothing for the last eighteen months. And that, too, is a positive.

 

Some may see the long, sideways grind as a top in the making, and there are certainly signs of a head and shoulders pattern in the making (see below). But remember, too, that every big leg up on the market occurs after a pause. And a pause laden with negative sentiment is all the more fertile ground for a stunning rocket-shot higher.

 

Three: Systemic Risk Issues.

 

In 2008/2009 there was a clear and present danger to the entire global banking system, as risk management practices went out the window and numerous institutions failed. Today, we don’t have the same worry. There are weak institutions, no doubt, and risk assets are not in favor, nor should they be, in all cases. But the banking system (and in particular, capital levels) is today better situated to withstand a stormy economic event. That speaks to a potentially shallower decline than many are expecting.

 

Four – A Weakening Dollar?

 

We saw a big tumble from the dollar yesterday on weak ISM numbers that suggested the economy is genuinely slowing. The market immediately shot higher. A weaker dollar would be a boon not just for exporters but for all those wanting to come to our fair shores to spend their cash.

WSJ Dollar Index

Look for the Fed to find a way to put downward pressure on the buck, particularly if…

 

Oil Prices Continue Weakening

 

Oil is the wild card. For a while, lower crude prices translated almost lock-step to declines in the stock market. That appears to have ceased momentarily, but we’ll have to get some crude co-operation here if the broad market is to see any sort of sustained rise. And technically, there’s no evidence of that occurring at this point.

 

To wrap it up, the long and the short of it all is oil and earnings. We’re just at the beginning of Q4 reporting at the moment, so some patience will be necessary. We do find hope, however, in the chart below, which indicates some spring of late in the shares of energy companies.

Rebound

On face, it appears oil company shares are reacting very positively to profit reports, an indication of a deeply oversold condition coming into earnings season that’s now being redressed.

 

We’ll see how it ultimately plays out.

 

Trading Advice

 

We have one trade to report before we turn to this week’s action.

 

It was an initiative you should remember as it was launched just last week using Home Depot (NYSE:HD) options.

 

The letter was called 2008? Again?, and there we recommended you buy the HD February 26th 121 PUT trading for $3.55, and sell three February 26th 113 PUTs trading for $1.38 each, for a total credit of $0.59. Then, we urged the purchase of the HD February 26th 129 CALL for $0.88. All included, your debit was $0.39.

 

And how’d we do?

 

Well, we’re leaving the three short puts alone and selling off both the long CALL and PUT. The former trades for $1.22, while the latter fetches $2.52.

 

We’ll be watching this one closely. Meantime, sit on your $375, and wait for the expiry of the shorts.

 

This Week

 

We’re going back to the oil sector for this week’s action.

 

In spite of our ignorance regarding which way is next for oil, the following chart tells us that if and when crude oil recovers the producers will recover a lot faster. And certainly the evidence we provided at the beginning of this post shows that the sector is poised to surprise to the upside after so long a drubbing.

 

Here’s the chart –

XOM

It’s heavyweight Exxon Mobil (NYSE:XOM) charted against the United States Oil Fund ETF (NYSE:USO), a proxy for NYMEX Crude.

 

And it suggests to us a pairs trade that will profit should XOM outperform (rise faster or fall slower) than USO.

Why Len Why

Exxon Mobil and crude parted ways nearly four months ago, when the market decided oil had to be taken to the woodshed. It was a move that coincided with the prospect of massive Iranian crude stockpiles coming onto the global market, a development that all but guaranteed a deep slide in the price of the commodity.

 

But with that, came a lot of speculative short selling, too, and that drove prices down too far, too fast. And the current volatility in crude is indicative of a bottom, as far as we can tell.

 

We also like the trade because Exxon’s RSI and MACD indicators look ready to cross above their all-important ‘waterline’ thresholds in the next few days (in blue), a development that would render the stock a technical ‘buy’. Moreover, it’s happening while crude is still splashing about near its lows.

 

We’re betting that XOM will hold its value in the face of any further weakness in crude.

 

For that reason,

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Options Trader Elite recommends you consider buying the USO July 10 PUT for $1.62 and selling the XOM July 65 PUT for $1.63. Total credit on the trade is $0.01.

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The USO option is already 5% in-the-money, while XOM’s is better than 15% out-of-the-money.

 

Many happy returns,

 

Matt McAbby

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