XLE – Oil price drop

XLE has been something of a problem with the rapid decline of oil prices. We are down over $4100 on the year – but we were down $6200 on Friday after XLE’s price collapsed. At DPO we have traded the XLE for a very long time and we have learned that it will, at times, swing wildly while moving way too high and way too low. It’s now clearly in a bear market but last Friday’s move was one of those exaggerated ETF swings that sometimes happen  – and it was multiplied by the holiday schedule and lack of liquidity. We fully expect XLE to settle down quickly and then slowly recover to some higher level –  while we are trying to stay net-short because of it’s bear market chart.  XLE is now decaying at a rate of $175 a day. Let’s  think about it like this: We have spent $4100 to create a trading position that is now earning $5425 a month. When you can make back your initial expenses in 30 days — that’s a pretty great business to be in!

Will we actually get “back to even” on XLE by the end of December? There is a very good chance we can make that happen if we manage this position correctly. I’m going to add XLE to the symbols that are being discussed here on DPO. It’s important to develop the skills to manage positions that are working, but it’s more important to learn how we manage positions that have not been working. Using options, just about every position can be repaired over time.

Our current XLE position is a rather complex collection of shares owned with covered calls sold, naked puts, and naked short calls. The bottom line is a DIA-weighted Delta of 217 with a daily time decay (Theta) of about $175. That is very close to the holy grail position which would be Delta near zero (little market risk) with Theta as high as possible. At first glance, it appears that the holy grail is risk-free, easy money. Sadly, that does not exist, as was proven last Friday. On that day, XLE was down about 6.5% while the DIA was basically unchanged. On that day, theoretical beta-weighted DIA Delta was meaningless.

At DPO – we have some maxims. One of those – “A single day’s action is meaningless”. This is nearly always true, but like everything in the business of trading, there are no absolutes. Some days do signal significant change in the markets, but they are actually exceedingly rare.

Stay optioned, my friend.


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