Exxon Mobil pulled back recently and so far is respecting support at the 50-day moving average. When it comes to options, we normally look at short-term trades. Anywhere from one week to one month. Today, we'll look at a longer-term bull put spread on XOM stock.
Setting Up A Bull Put Spread For XOM Stock
As a reminder, a bull put spread is a defined risk strategy, so you always know the worst-case scenario in advance.
This type of trade profits if XOM stock trades sideways or higher and even sometimes if it trades slightly lower.
In this case, we'll look at a longer-term option with an expiration five months out. Longer-term option trades tend to move a little slower than shorter-term trades. That allows more time to adjust or close, but also means a lower annualized return.
With XOM stock trading around 112, we can sell a 100-strike put and buy a 95-strike put to set up the bull put spread with a June 16 expiration. That spread traded around $1.05 yesterday. Keep in mind that liquidity is lower in longer-term options which means it can be harder to get a good fill price.
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Selling this spread on XOM stock generated roughly $105 in premium. That's also the maximum profit. Taking the difference between the strikes and subtracting the premium received gives you the maximum risk of $395.
Managing The Trade
If XOM stock is above 100 at expiration, the spread expires worthless. That also achieves the maximum profit and a 26% return on risk in five months.
The maximum loss of $395 occurs if XOM stock closes below 95 at expiration.
The break-even point for the trade is 98.95. That calculation takes the short strike of 100 and subtracts the 1.05 option premium per contract.
I would set an adjustment point or a stop loss if XOM stock drops below 105. Otherwise, another good rule of thumb is to limit the loss to the amount of premium received, which in this case would be $105.
Sticking to this stop loss level will help avoid large losses if the trade goes south.
According to the IBD Stock Checkup, XOM stock is ranked No. 5 in its group and has a Composite Rating of 86, an EPS Rating of 77 and a Relative Strength Rating of 87.
It's important to remember that options are risky and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
