ExxonMobil put in a nice performance yesterday while also reclaiming the 50-day moving average. After sitting out most of this year's rally, is it time for XOM stock to move again?
Bull Put Spread With More Time
When it comes to options, we normally look at short-term trades. Anywhere from one week to one month. Today, we will look at a longer-term bull put spread on XOM stock.
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.
As a reminder, a bull put spread is a defined-risk strategy. You always know the worst-case scenario in advance. A bull put spread profits if XOM stock trades sideways or higher and even sometimes if it trades slightly lower.
With XOM stock trading around 106, if we use the Jan. 19 expiration, we can sell a 100-strike put and buy a 95-strike put to set up the bull put spread. That spread was trading around $1.40 per share this morning.
Keep in mind that liquidity is lower in longer-term options which means it can be harder to get a good fill price. XOM stock is a very liquid name, however, so it shouldn't be as much of a problem for this trade.
Selling this spread would generate roughly $140 in premium for a block of 100 shares with a maximum risk of $360.
If XOM stock is above 100 at expiration, the spread expires worthless. That gets you the maximum profit by keeping the full premium. It works out to a 39% return in just over six months.
Managing The XOM Stock Option Trade
The maximum loss would occur if XOM stock closes below 95 on Jan. 19. The long put offsets losses in the short put to limit the loss on the trade. The most the trade can lose is $360. That's the distance between the strike prices less the premium received multiplied by 100.
The break-even point for the trade is 98.60. To calculate the break-even take the 100 short strike less the 1.40 option premium per contract.
I would set an adjustment point or a stop loss if XOM drops below 100. Otherwise, another good rule of thumb is to limit the loss to the amount of premium received, which in this case would be $140.
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. 19 in its group and has a Composite Rating of 27, an EPS Rating of 32 and a Relative Strength Rating of 31.
Please 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.
