Oil ETFs: When is a drop a threat, and when is it a sterling opportunity?
By Adam Lass
In this article
Context is everything when it comes to interpret large price drops.
When the Dow peeled off 3.21% last week, it broke a critical trendline.
When the XLE dropped 3.55% yesterday, it held support on its trendline.
Oil ETFs: When is a drop a threat, and when is it a sterling opportunity?
Today is the first day of summer. At least that's what the calendar says. And while today may very well be the longest day of the year, here in Maryland, we have been wearing T-shirts, baggy shorts and sandals for weeks now.
Now I know that the thought of your dear correspondent's unsightly knees is surely enough to drive one to drink, but their exposure is hardly intended as a fashion statement. Rather it is the only way to survive in a town when both thermometers and humidistats crested 99 back in May.
So when does summer truly start? Today? Memorial Day? How about the first day when you can fry an egg on a Baltimore sidewalk? What matters more: a date on the calendar or a notch on the thermometer?
In a recent e-mail conversation, I found myself quibbling a similar idea re: the market: what exactly constitutes “a drop” worth paying attention to? Is it the amount of points or is lost percentage more important?
And speaking of really, really important, is it a moment of terror or a buying opportunity?
Obviously, you have to place a drop in context. Fortunately the market is offering up two examples, in that both the blue chips as a group and energy stocks in particular have put in some pretty dramatic “drops” lately.
Over the past few weeks, the Dow Jones Industrials have put on and then peeled off 439 points. Right now, it is sitting right between its recent highs and lows while investors ponder whether risk outweighs upside.
And quite honestly, I would have to say it does. It's not just that it is the traditional season for 5% losses. Or that the Fed may very well be forced to jack rates sooner rather than later.
Although both facts may very well impinge on the investoriate group conscience, they are still “elastic ponderables.” That is to say that they don't matter to share prices until the crowd says they do, and the best way to determine that is a trend study.
Looking at the Dow, we see a critical trendline broken. Link every bottom from early May till early March, and you get a clean line in the sand, a line that price waded across with both feet back on June 7, and has never regained. But not for lack of trying: The Dow attempted to climb back into that rising trend Friday, and again on Monday and Tuesday, and these three failures serve as confirmation that this “drop” is indeed cause for concern.
But energy stocks are another story altogether. Just yesterday, we saw the XLE give up 71 points in a single brutal session as crude oil futures peeled away more than a dollar a barrel. Percentage-wise, the 71.8 points the XLE gave up represents a 3.55% loss, par or even a hair larger than the Dow's 439-point 3.21% loss.
But -- and this but means everything -- the XLE held at the bottom line of its rising trend. In fact, it has tested this particular line in the sand some nine times, and always bounced. In fact, this singular pattern has offered up the most reliable trading thesis in 2007: Buy dips in oil.
So far this year, WOW readers have witnessed gains of 20.51% and 111.11% off XLE call options, 96.55% off El Paso Energy (EP:NYSE) call options and 132.14% and 287.35% off Chevron (CVX:NYSE) call options. And those are only the official positions. Lord only knows how much they made off our constant (possibly even droning) reiteration of this basic tenet.
Indeed, yesterday's XLE drop has once again triggered this most consistently profitable signal in my arsenal. As I sit to write to you, XLE July 70 Calls (XBT GR) calls are being offered for $1.75 per contract, with a delta of 0.52. Should the XLE rise as predicted, these options could gain as much as 72% in eight trading days.
Buy the XLE July 70 Calls XBT GR today below $1.85, with a 35% protective trailing stop and a 70% gain target.
***
Adam Lass is the founder and manager of the WaveStrength Group, and is a contributing editor for Taipan Financial News. As the creator of WaveStrength's proprietary analysis system, Adam's expertise has shaped a franchise of successful investment newsletters and services, including WaveStrength Options Weekly and WaveStrength Apex.
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