A large institutional trader decided today was a good time to put on a large and slightly complex options trade in the XLE (Energy Select Sector ETF ). This options trade which is called a risk reversal involved buying 30,000 June $61.50 strike XLE call options for a debit of roughly $5.8 million and selling 45,000 June $45.00 strike XLE put options for a credit of roughly $6 million.
The trader (hedge fund) that put this trade on has received a net credit of roughly $200,000, however, this is a risky trade with significant profit/loss potential depending upon the future course of XLE. The options payoff/loss profile for this risk reversal looks roughly like this:
In theory this options trade has unlimited profit potential in the event that the XLE share price soars to the moon. However, in the event that the energy sector downtrend persists and XLE slides below $45 this options trade is exposed to $4.5 million of loss for each $1 that XLE is below $45 at the June options expiration date. For example if this trader holds this risk reversal through June expiration and XLE closes on June expiration Friday at $70/share this trader will be looking at a net profit of roughly $31.5 million. Whereas, if XLE shares are trading at $35/share at June expiry this risk reversal will be facing a ~$45 million loss.
Aside from the fact that this is a relatively massive options trade, there are two things that stand out from a technical analysis standpoint about the strike prices chosen: 1. The $45 level is the measured move target of the large topping pattern which formed between August and December last year. 2. $61.50-$62.00 represents important support/resistance and the 38.2% Fibonacci retracement of the entire decline since last May.
The strike prices of this options trade clearly weren’t chosen accidentally and just judging by the size of this options risk reversal there is at least one large institution that is bullish on large cap energy stocks (integrated E&Ps, refiners, and oil service firms) during the 1st half of 2016.