Shorting overbought and overhyped oil and oil stocks (XLE) with a levered up but lower cost inverse oil stock ETF (ERY).
Actually, markets overall have been volatile and chaotic recently. The recent push past 4.5% on the 10-year Treasury yield appears to be the essential catalyst for taking stocks lower and rates of interest higher.
Even oil prices weren’t immune as the worth of crude dropped sharply from over $93 barrel to finish September to under $83 barrel to finish the primary week of October.
The siren calls for oil going to $130 and even $150 by most of the experts proved once more to be misplaced. Sounded very very like similar prognostications back in 2008 when predictions of oil hitting $200 barrel proved wildly improper.
At any time when the chatter gets this hyperbolic, it is sort of invariably an opportune time to take a position contrary to the prevailing calls. That’s exactly what we did only recently with a short-term bearish trade in oil stocks.
Why We Did It
Each the worth of oil and oil stocks (XLE) hit an extreme in mid-September. The chart below shows the XLE over the past yr. You may see how once more shares had reached overbought levels as highlighted in blue. 9-day RSI was nearly 80. Bollinger Percent B was over 100. MACD was at an extreme. XLE was trading at an enormous premium to the 20-day moving average. Previous times all these indicators aligned similarly marked significant short-term tops in XLE.
Crude oil prices exhibited similar overbought readings. But we selected to short oil stocks as a substitute of oil just because oil stocks had had a fair greater rally than oil itself recently. A comparative chart below illustrates that time.
(*3*)
You may see how oil stocks (XLE) and oil moved in just about unison until a little bit over a yr ago. Is smart since oil and oil stocks must be fairly well correlated. Since then, oil stocks have rallied sharply while oil itself has actually fallen. Indeed, XLE was up 4 times as much as West Texas Intermediate Crude ($WTIC) over the past two years.
We expected oil stocks to start to converge back to grease prices over the near term, which is why we selected to short the stocks like ExxonMobil and Chevron that make up the XLE over shorting physical oil itself.
How We Did It
Slightly than short XLE, which may expensive and dangerous, we selected as a substitute to make use of an inverse ETF that increases in value if XLE falls. In truth, the inverse ETF we ultimately chosen increases at a faster percentage rate (2 times) versus the drop in XLE. The ETF we picked was ERY. Description from the Direxion website shown below:
The Direxion Day by day Energy Bear 2X Shares seeks each day investment results, before fees and expenses of 200% of the inverse (or opposite) the performance of the Energy Select Sector Index (XLE). There isn’t any guarantee the funds will meet their stated investment objectives.
So, we were capable of buy ERY at under $25 fairly than having the margin requirement of shorting XLE of just about $50 (1/2 the worth of XLE is the initial short requirement). In essence, half the monetary commitment. Plus, get twice the potential return (albeit with twice the potential loss). Vital to keep in mind that these levered ETF products are specifically designed for shorter term investments fairly than long run buy-and-hold. This matches our typical trade time-frame as well.
Why We Covered
The chart below shows ERY over the past yr. Notice the way it moves just about in an opposite manner to the XLE chart, but to a greater magnitude. While oil and oil stocks (XLE) hit oversold readings on Thursday, ERY concomitantly got to overbought levels at the identical time.
We went long ERY at $24.02 on 9/11/2023 and subsequently exited the position on 10/5/2023 at $27.50. Net gain on the trade was 14.49% with a holding period of lower than a month.
Compare those returns to shorting oil, which dropped just over 5% in the identical time-frame. Oil stocks (XLE) dropped about 7% over that period.
As anticipated, oil stocks did worse than oil. Using ERY as a approach to leverage up the gains on a drop in oil stocks work just as expected with double the gain.
Not all trades work out this well or this quickly. But for traders trying to put the percentages of their favor, combining technical evaluation together with examining correlation performance, plus using alternative approaches, can put the percentages in your favor.
At the top of the day, profitable trading is all about percentages, not certainty.
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All of the Best!
Tim Biggam
Editor, POWR Options Newsletter
XLE shares closed at $85.73 on Friday, up $0.51 (+0.60%). 12 months-to-date, XLE has gained 0.64%, versus a 13.57% rise within the benchmark S&P 500 index through the same period.
Concerning the Creator: Tim Biggam
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 a Market Maker for First Options in Chicago. He makes regular appearances 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 comprehensible and subsequently more useful to the on a regular basis trader.
Tim is the editor of the POWR Options newsletter. Learn more about Tim’s background, together with links to his most up-to-date articles.
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