Second Chance At An Energy Play With 50% Upside

second-chance-energy-playFor some investors the volatility in energy prices, particularly crude oil, has been nothing but headache. However, for those investors willing to use long options on oil, the rewards will far exceed the risk. This is particularly true when using a small outlay to leverage your upside potential.

What a beginning of August it was for Crude Oil, marking new multi month lows below $40 a barrel then reversing to close higher on the week.

As of this writing, Crude has climbed back to the $43 midpoint from the $33 to $53 rally run in 2016. The New Year upturn has finally backtracked to give BULLS a better risk to reward buying base.

XLE is a diversified Energy exchange traded fund with Exxon and Chevron making up a third of the weight.

XLE

Action was stuck sideways between $64 and $68 in the last three plus months until Monday. The upside breakout above the $68 top targets a measured move with the $4 width of the trading channel on top to $72.

That move to new annual highs sets sights on the larger objective as the midpoint resistance at $75 from the XLE 2014 $100 peak to the January $50 extreme low.

The XLE $75 target is 10% up above. That would be a healthy return performance, but let me show you how to multiply those gains FIVEFOLD and lower the investment cost and risks at the same time.

SIMPLE STOCK SUBSTITUTION STRATEGY

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 January option has more than five months plus for Bullish development.

An In-The-Money option gives you the right to 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.

With XLE trading at $68.50, for example, an In-The-Money $60.00 strike option currently has $8.50 in real or intrinsic value. The remainder of any premium is the time value of the option.

Trade Setup: I recommend the XLE March $60.00 Call at $10.00 or less. A close in the stock below $64 on a weekly basis or the loss of half of the option premium would trigger an exit.

XLE

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 much less money tied up in the investment. The Delta on the $57.00 strike call is 80%+.

The January option has more than five months plus for bullish development. This option is like being long for the stock from $60.00 with completely limited risk.

The maximum loss is limited to the $1,000 or less paid per option contract, with a stop loss exit at half of that premium to risk less than $500. The upside potential, on the other hand, is unlimited.

The XLE option trade break even is $70.00 or less at expiration ($60.00 strike plus $10.00 or less option premium). That stands $1.50 above the current price.

If shares hit the $75 midpoint price of the $100 drop to the $50 lows, the option would be worth $15.00 for a 50% return on investment.

Be sure to also check out Bret Jensen’s biotech gems if you want a good counterbalance to oil plays.

 

Note: The author of this article is Alan Knuckman.

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Category: Options Trading Strategy

About the Author ()

The author of this article is a contributor to Investors Alley.