Previously a sale, the recent big drop in crude oil has caused Big Oil to make a purchase. How to position to take advantage of continued consolidation in XOM stocks.
A little over a month ago I wrote why I thought oil and oil supplies were short in “5 reasons why it’s finally time to sell big oilThe fundamentals, technical data and implied volatility all reached extremes. Probabilities favored a pullback.
Now that oil and oil inventories have fallen by more than 15% in the past 30 days, my opinion has also changed. Price matters. My previous bearish outlook has changed to a more neutral to slightly bullish stance. Let’s take a look at three reasons why the worst is over for the recent crude oil massacre. Again, I’ll be using ExxonMobil (XOM) as the banner for Big Oil.
ExxonMobil stock traded near historically rich valuations last month. P/S was then more than 1.4x and by far the richest multiple of the previous 12 months. With XOM plummeting from highs, valuations are much more attractive. The current P/S ratio is below 1.18x and is approaching its lowest multiple in the past 5 months.
Other traditional fundamental metrics such as P/E and P/FCF show a similar decline. The current P/E stands at just over 14x and is below the 10-year average of 15.23X. Analysts are: expect ExxonMobil to benefit strongly from higher refining margins and raised FY2022 earnings estimates to over $11.50 per share. This equates to a future P/E of less than 8, which should attract value investors.
ExxonMobil reached oversold values before finally bouncing. 9-day RSI crossed 30 and then moved higher. MACD touched lower for a year before gaining significant strength. Bollinger Percentage B went negative but has since returned to positive territory. XOM shares traded at a sharp discount from the 20-day moving average. Stocks again hit key longer-term support at $82.
Back in the day, all of these indicators aligned in a similar fashion, marking significant lows in ExxonMobil stock. The fact that it happened at a key support level makes it an even more powerful indicator.
Last month, XOM’s stock option prices were quite low. Implied Volatility (IV) traded at just 34e percentile. However, the punitive relapse has greatly boosted IV. Current IV is now at the 79th percentile. This means that option prices have gone from fairly cheap to quite expensive, selling options over buying options when constructing trades.
Peaks in IV are also often a reliable bullish opposite indicator. Consider how big booms in the VIX have often been a sign that the fear is extreme and the lows are just around the corner.
How to trade it now?
A month ago I recommended looking at buying puts on XOM as an effective way to position for a pullback. Stocks were overvalued, overbought and IV was cheap. That trade would have worked out well given the subsequent big drop in ExxonMobil shares.
Now, however, ExxonMobil looks much better from a valuation perspective. Shares are oversold. Option prices have become much more expensive. So instead of buying puts in position before a pullback, selling puts (or put spreads for lower risk traders) is the optimal way to take advantage of the ongoing consolidation around the key support area at $82.
Legendary trader Paul Tudor Jones has a saying, “Adapt, Evolve, Compete or Die”. In this market environment, the ability to adapt to rapidly changing market conditions and develop your trading strategy is even more important.
What to do?
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All the best!
XOM shares closed Friday at $84.54, up $1.40 (+1.68%). Year-to-date, XOM is up 41.12%, versus a -18.31% rise in the benchmark S&P 500 index over the same period.
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as Market Maker for First Options in Chicago. He appears regularly on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network “Morning Trade Live”. His overriding passion is to make the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of the POWR options newsletter. Read more about Tim’s background, along with links to his most recent articles.
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