A high-probability options trade that wins if the comeback rally in energy stocks hits a wall
Oil has been experiencing a face-ripper rally since February and it has been in overbought territory since March. It is now rapidly approaching a price level which could serve as short-term resistance. With this view in mind, I am looking for a bearish setup in the VanEck Oil Services ETF (OIH) . This ETF seeks to track the largest, most liquid companies involved in oil drilling and selling oil equipment based on market capitalization. Its largest holdings include companies like Schlumberger and Halliburton. To confirm my bearish, I have taken into account two factors: Although OIH is approaching a multi-year high, the $360 price level could also serve as overhead resistance. Further, RSI (Relative Strength Index) which measures the strength of the current momentum is showing a divergence. This is evident in RSI dropping to 70 after being in overbought territory for last 3 weeks. The Trade Setup: Bear call spread The strategy I’m employing here is known as a “bear call spread.” Looking at the charts, I’m betting that OIH won’t surpass $360 within the next 24 days. To execute this, I can simply sell a $360 call option, bringing in a credit of around $430. This trade profits if OIH remains below $360 upon expiration. However, my trading platform indicates that this will tie up $5,500 of portfolio margin, a significant amount for a potential profit of just $430. To lower the margin requirement, I can simultaneously purchase a $365 call option, costing me $297. This drastically reduces my margin requirement to $367. Yet, since I’m paying a debit for the $365 call, it also decreases my profit potential from $430 to $133. OIH 1Y mountain VanEck Oil Services ETF (OIH), 1-year According to the option chain on OIH, the probability of OIH expiring at or below $360 by expiration date stands at 71.4%. This makes it a high-probability trade with favorable odds of success. Here is my exact trade setup: Sell $360 call, May 3rd expiry Buy $365 call, May 3rd expiry Potential Profit: $133 Max Loss: $367 If OIH is trading below $360 on expiration date, I get to keep the full premium of $133 that this trade will bring in. Scaling up Scaling up is as easy as adding more contracts. By adding 10 contracts, I have the potential of making $1330 by risking only $3670. Compare this to selling a naked $360 call option which was bringing in only $430 while tying up $5,500 in portfolio margin. This is a high probability trade which means I can expect 7 out 10 such trades to be winners. However, note that the losses are bigger than the profit. I will need a good trade management plan with a stop loss in case the trade starts going against me. -Nishant Pant Founder: Author: Mean Reversion Trading Youtube, Twitter: @TheMeanTrader DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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