Oil Stock’s Upside Target Could Return 50%-Plus Profits for Traders
Crude oil prices have formed a bottom base with the recent asset recovery. The range between $91 and $85 that has lasted in the commodity for more than two months has an upside target of $97 per barrel.
Marathon Oil Corporation (NYSE:MRO) also has an attractive technical pattern with a breakout from the $4 trading range above $32. The near term target sits at $36, which would be a new 52-week high.
A bigger price wedge from the $24 low base suggests a larger move to $40, and even to the 2007 peak above $60, is possible. Only close below the $28 support level on the weekly basis would negate the bullish trend.
The $36 target is about 12.5% higher than current prices, but traders who use a stock substitution strategy could make more than four times that amount on a move to that level.
One major advantage of using long call options rather than buying shares is putting up much less 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.
Simply put, 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 an option with 70%-plus probability.
Delta is a measurement of how well an option follows the movement in the underlying security. It is important to buy options that pay off from a modest price move in the stock or ETF rather than those that only make money on the infrequent price explosion.
Any trade has a 50/50 chance of success. Buying in-the-money options increases that probability. Delta also approximates the odds that the option will be in the money at expiration. In-the-money options are more expensive, but they’re worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.
For example, with MRO trading at about $32 at the time of this writing, an in-the-money $26 strike call currently has $6 in real or intrinsic value. The remainder of any premium is the time value of the option.
Rule Two: Buy more time until expiration than you may need — at least three to six months — for the trade to develop.
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 has expired.
I recommend the MRO July $26 Calls at $6.50 or less.
A close below $28 in the stock on a weekly basis or the loss of half of the option premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $650 or less paid per option contract. The upside, on the other hand, is unlimited. And the July options give the bull trend six months to develop.
This trade breaks even at $32.50 ($26 strike plus $6.50 option premium). That is about $0.50 above MRO’s current price. If shares hit the upside breakout target of $36, then the options would deliver a gain of more than 50%.
Recommended Trade Setup:
— Buy MRO July 26 Calls at $6.50 or less
— Set stop-loss at $3.25
— Set initial price target at $10 for a potential 54% gain in six months