Yes, There Are Bearish Plays to Make Here

Sean McLaughlin
September 10, 2020

You'd be forgiven if you read this headline and completely discarded this blog post to the trash heap. I feel you. But assuming you're reading these words, you seem to be willing to entertain the possibility of "unpopular" ideas.

In my experience, when getting bearish on a stock or an index, it is rarely a smart play (statistically speaking) to purchase straight long puts. The reason being that if I'm spotting a bearish opportunity, then likely the rest of the world sees it too and therefore people are probably getting nervous and beginning to hedge their long positions with puts or are starting to bid up speculative downside bets. In either case, it usually inflates the implied volatility in the options pricing, making puts an unfavorable purchase.

But every so often, we find a case where a stock or an index has really just worn people out and people have just lost interest. And when the security starts to show signs of losing support, the opportunistic speculator can get ahead of the crowd before the opportunity becomes obvious to everyone else.

This appears to be the situation in the Energy Sector ETF $XLE.

Here's Steve Strazza is a recent report to All Star Charts institutional customers:

After such a relentless effort from the bears, we have to ask ourselves how much buyers have left in the tank at this point, especially now with Crude Oil breaking down. These are looking a lot less like failed breakdowns these days, and a lot more like false starts. The tests are becoming more and more frequent as the rebounds off support become weaker and weaker. Not to mention, price just broke to all-time lows relative to the S&P 500. When we weigh all these things together, the outlook isn’t good for Energy stocks. If XLE violates its July pivot low of 34.25 we want to be short with a 1-3 month target at the March lows near 23.

This week, $XLE did indeed break the $34.25 level. And most notably to me, implied volatility remains pretty tame:

It doesn't happen often, but this sets up a straight long puts play.

Here's the Play:

I'm looking to buy $XLE December 29 Puts for $1.25 or better. This is a defined risk play (the most I can lose is the premium I paid up front).

My risk management plan is as follows: If $XLE closes above $37/share at any time during this hold, I'll close the puts down for whatever I can salvage (if anything). On the winning side, I'll take profits at two points:

  1. I'll sell half of my position if I can do so for $2.50 per contract or better. This will remove all of my original risk from the position.
  2. I'll sell the remainder of my position if we hit the ASC price target of $XLE March lows below $23.00.

Bearish moves are known for violent whipsaws and dead cat bounces. So unlike a long call play, I'm going to be aggressive in taking profits here when our price target is hit, instead of holding on for the possibility of "unlimited" gains.

All Star Options subscribers with questions on this trade, please send them here.

For the rest of you, come check out All Star Options Risk Free!!

~ @chicagosean

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