Option Investor

Time To Take Profits?

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That is a really tough question and one I am not sure how to answer. I must have gotten a dozen emails this week asking if we should pocket some of the cash we are holding. This is where emotion meets reality.

Emotionally I would love to hold on to them with a target of $73 given the amassing of fundamental reasons for a continued spike in oil. However, despite the overwhelming reasons to stay invested there are just as many reasons to pull the ripcord and bail out. We should not have sellers remorse in taking a $12 profit in APC or COP. VLO is nearing $14. We have nursed those positions for months and I would hate to see them turn to dust on some serious profit taking.

While the longer term reasons for a continued ramp in oil are very strong there is also uptrend resistance at $68. We are very close and I am sure you noticed that most energy stocks did not participate in the continued rally in oil on Friday. Traders are getting nervous. Hedge funds need to pocket some profits to keep their investors in the fund. The same goes for the stodgy old mutual funds who are riding the coat tails of the aggressive players.

I have to admit when oil spiked to $66 on Thursday morning I bailed on a bunch of short-term positions. When it continued up on Friday I was ready to back into the kicking machine until I noticed that the majority of stocks were not participating. My favorite momentum stock, Valero, continued to hit new highs and tacked on another buck. My favorite trading stock, AHC, got positively crazy with a +2.68 gain. Those were the exceptions to the rule.

Now I have to decide if the group reluctance to follow oil higher was just profit taking ahead of the weekend or the leading edge of a bigger dip next week. With oil up +7% for the week there is a good chance there will be a strong dip soon. Since the majority of the stocks only lost a few cents each I am not really too worried yet. Storm clouds are gathering in the Caribbean and there is no shortage of negative events in the sector.

The last day of trading for the September contract is August 22nd and I am wondering if we are going to see a short covering spike to the moon or some serious profit taking ahead of the event. I am betting that there are more traders just along for the ride than those who want to take delivery of the product. That suggests we will see profit taking by the end of the week.

When the August contract (CL05Q) ceased trading on July 20th we saw a -2.20 drop to $56.20. This was in addition to a weeklong weakness starting at $61. I don't know about everyone else but a $5 drop is a serious drop. It would make a good buying opportunity but it would also erase a lot of profit.

August expiration on CL05U chart

We are talking about changing the format of this newsletter from LEAPS to an Energy newsletter. This would allow for a broader range of strategies in addition to the leaps and allow for things like a mass exit ahead of a contract expiration date. Many LEAP traders don't want to exit short term due to the higher tax implications. Traders on the other hand just want to take profits over and over again. If we change the format we can offer both. Let me know how you feel about this topic. Send me your comments to Jim at Option Investor.

After that long explanation we are back at the decision point again. Take profits or let it ride? The July dip to the August contract expiration was a two-month low and a perfect entry point for new positions. Compounding this problem is the exact opposite in the July contract (CL05N), which expired on June 21st. It saw strong buying right into expiration as shorts got squeezed for an additional +$7. The June contract (CL05M) fell -$7 in the last nine days of trading into the May-20th expiration. That was also a two-month low and a perfect entry point.

July expiration on CL05U chart

June expiration on CL05U chart

All expirations on CL05U chart

I bet you are really confused now. It appears there is a high directional coefficient attached to the contract expiration and the difference has been nearly a $14 spread depending on the direction. About the only thing that is clear to me is that we are likely going to be highly directional beginning on Monday and it is a coin flip for direction. With the propensity for traders to short new highs I am hoping there are a lot of them who have to cover next week. We closed right at the high for the day and the month and there are no signs of weakness. You would think that at least some traders looking to bail next week would have headed for the exits at the Friday highs and never looked back. We did not see any evidence of that happening. Over the last ten months we have seen an upside bias into the expiration eight times and a downside bias twice.

This give me a positive bias for next week but I am going to hedge my bets by tightening all the stops and we will take profits only if forced. Using this same logic a short squeeze next week could take us to $75. That would setup an even stronger potential for profit taking once the September contract expired. For that reason I am going to target $73 oil as our exit point. If we are lucky enough to get the upside flip instead of the downside dip I want to exit our big winners at $73. I will note in the individual play narratives which ones to exit.

December Natural Gas Chart - Daily


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