Is it time to get long the refiners?

Shutterstock photo

Oil refiners including Valero Energy have been building a base this year after a miserable 2009, and now the activity is turning bullish.

Stocks such as VLO, Sunoco, and Western Refining are up at least 13 percent since Jan. 1, more than double the performance of the S&P 500. That marks a big change from last year, when all three registered double-digit losses and the broader market surged 28 percent.

Option activity has also been turning more bullish, especially for VLO. Not only have calls outnumbered puts by more than 2 to 1 over the last month, but the calls were largely purchased while the puts were sold. Similar buying patterns, which reflect an upside bias, appear on a much smaller scale in SUN and WNR.

VLO Chart Both technical and fundamental trends suggest that better times lie ahead. The most important technical indicator is their relative outperformance versus the broader market.

VLO, SUN and WNR also show broad basing patterns while their moving average convergence/divergence indicators suggest that positive momentum is building. The so-called MACD oscillator, while not a perfect tool, behaved similarly on the S&P 500 as it bottomed in March 2009 and March 2003.

There are also bullish factors developing for the refiners on a fundamantal basis after several quarters of losses and restructuring charges. These companies now face the prospect of improving demand from the U.S. consumer shortly after cutting large amounts of capacity. That's a similar positive combination that the airlines faced about six months ago, and most of them have roughly doubled since then.

VLO's last earnings report on Tuesday showed this turn for the better: The loss was narrower than expected and revenue beat forecasts, while the operating margin improved from -1.17 percent in the fourth quarter to -0.16 percent in the first quarter.

If investors believe that the stocks are near their lows, they may want to consider options rather than simply buying the shares. One moderately potential strategy is the combination trade, which can generate big leveraged gains at minimal expense.

For instance, an investor could sell VLO's December 19 puts for $1.83 and buy the December 22 calls for $1.83, resulting in no outlay except for the commission. The trader would profit if shares rose above $22 and face losses below $19.

I particularly like this trade because the stock established support around $19 last week, which reduces the risk of loss. VLO rose 2.66 percent to $20.43 yesterday.

This is reminiscent of a trade on Gap last spring, when the shares were sitting at support and the retailer's business was improving. An investor took maximum advantage of that setup using options and earned a quadruple-digit return from a 25 percent move in the share price.

The situation now looks similar for refiners. Their fundamentals are improving and their charts are showing significant upside potential with limited downside risk. It could be a good time to place a long-term bet using options.

Disclosures: I am long VLO.

(Chart courtesy of tradeMONSTER)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.

This article appears in: Investing , Options
Referenced Symbols: GPS , SUN , VLO , WNR

More from optionMONSTER




Follow on:

Research Brokers before you trade

Want to trade FX?

Find a Credit Card

Select a credit card product by:
Select an offer:
Data Provided by