Energy prices are on the move once again. Crude oil is at
five-month highs and solidly above $100 a barrel. And natural gas
hit multiyear highs with severe cold weather across North America
and no end yet in sight to this record-breaking winter. Add in
the macroeconomic picture of increased demand worldwide, and it's
likely that this bullish trend will continue.
, which provides offshore contract drilling services for oil and
gas wells around the globe, has been trading sideways in a $20
trading range from $60 to $40 since August 2011. This
two-and-a-half-year channel has held support at $40 so far in
2014, with a new 52-week low made this week just above $41.
Traders should note that this new low did not coincide with
new highs in volatility, and a bullish divergence such as this is
often a sign of price stability and could mark a bottom after a
long-term decline. RIG has long-term support at $38 dating back
to December 2011.
RIG is surely a market laggard, down 16% during the past 52
weeks, which is in sharp contrast to the record run in most
stocks over the past year. But it could make a big move higher as
energy prices continue to rise and shares play catch up.
The midpoint of the large, two-year-plus trading range
discussed above sits at $50. Additionally, the shorter-term $56
to $44 range also has a midpoint target of $50.
#-ad_banner-#The $50 target is about 16% higher than recent
prices, but traders who use a capital-preserving, stock
substitution strategy could make 70% on a move to that level.
One major advantage of using a long
rather than buying a stock outright is putting up much less
capital to control 100 shares -- that's the power of leverage.
But with all of the potential strike and expiration combinations,
choosing an option can be a daunting task.
You want to buy a high-probability option that has enough time
to be right, so there are two rules traders should follow:
Rule One: Choose a call option with a delta of 70 or
is the level at which the options buyer has the right to purchase
the underlying stock or ETF without any obligation to do so. (In
reality, you rarely convert the option into shares, but rather
simply sell back the option you bought to exit the trade for a
gain or loss.)
It is important to buy options that pay off from a modest
price move in the underlying stock or ETF rather than those that
only make money on the infrequent price explosion.
are more expensive, but they're worth it, as your chances of
success are mathematically superior to buying cheap,
that rarely pay off.
The options Greek
approximates the odds that an option will be in the money at
expiration. It is a measurement of how well an option follows the
movement in the underlying security. You can find an option's
delta using an options calculator, such as the
one offered by the CBOE
With RIG trading near $43 at the time of this writing, an
in-the-money $33 strike call option currently has about $10 in
real or intrinsic value. The remainder of the
is the time value of the option. And this call option currently
has a delta of about 90.
Rule Two: Buy more time until expiration than you may
need -- at least three to six months -- for the trade to
Time is an investor's greatest asset when you have completely
limited the exposure risks. Traders often do not buy enough time
for the trade to achieve profitable results. Nothing is more
frustrating than being right about a move only after the option
With these rules in mind, I would recommend the RIG Jan 2016
33 Calls at $10 or less.
A close below $38 in RIG on a weekly basis or the loss of half
of the option's premium would trigger an exit. If you do not use
a stop, the maximum loss is still limited to the $1,000 or less
paid per option contract. The upside, on the other hand, is
unlimited. And the January 2016 options give the bull trend
almost two years to develop.
This trade breaks even at $43 ($33 strike plus $10 options
premium). That is only a few cents away from RIG's recent price.
If shares hit the $50 target, then the call option would have $17
of intrinsic value and deliver a gain of 70%.
Action to Take -->
-- Buy RIG Jan 2016 33 Calls at $10 or less
-- Set stop-loss at $5
-- Set initial price target at $17 for a potential 70% gain in 22
This article originally appeared on ProfitableTrading.com:
A $1,000 Bet on This Offshore Driller Could
Land Traders 70% Profits