[Options] Sapping Energy

Sean McLaughlin
December 16, 2020

The Energy sector has had some interesting moves in both directions in 2020.

Sell off with everything else in March. Hard bounce with everything else in the Spring. Then a slowly accelerating slide into mid October where it caught another bounce.

But what's notable to me is that the down move which ended in October did not undercut the March lows, and the current recovery seems to be running out of steam below the June highs. Feels to me that Energy, and it's $XLE sector ETF is consolidating. 

And of all the ETFs I track, XLE is currently showing the highest implied volatility. So all this adds up to a great candidate for a delta neutral credit spread.

Here's the Play:

I'm selling an $XLE January 37/44 Strangle for a $1.25 credit. This means I'll be naked short 37 puts and an equal amount of 44 calls.

January expiration is only 30 days away. As such, theta decay is beginning to accelerate and that's what we're trying to capture here.

There is theoretically unlimited risk in this trade, so there are two things of importance here:

  1. I'll be sizing my position such that if I were to get assigned against my short calls, the position would represent approximately 10% of the capital in my account. This keeps me from getting into too much trouble.
  2. I'll be exiting the trade (win or lose) if $XLE breaks above $45 per share or falls below $36.

No arguing with the market when our potential losses are unlimited.

Why risk putting on a trade with theoretically unlimited risk? We're willing to do this because this trade compensates us with a high probability of success -- especially if our goal is to take our profits when we can cover (close the entire position) for half of what we collected at initiation.

So my plan to take profits is to close this spread when I can buy it back for 62 cents. I'm not going to be greedy. I'm going to take these tactical profits and then move on.

If subscribers have any questions on this trade, please send them here.

~ @chicagosean

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