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After writing about Marathon Oil (NYSE: MRO) in yesterday’s article, I didn’t necessarily want to write about another big oil company today. But the weekly chart for Chevron (NYSE: CVX) was just too enticing not to write about. The stock is just under $125 a share right now and this area as acted as resistance on four previous occasions over the past year. It is easy to see the trips up to the resistance line in May, July, September and December of 2013. The more interesting item of note is how each time it was rejected at the resistance, the ensuing drop took the stock down a little lower each time.
It is rare to see a blue chip stock hit resistance at the same level four times without breaking through. The current test of the level is the fifth and even though the stock is overbought on the daily and weekly Chevron stock charts, I look for it to break through this time.
One of the reasons I like the stocks chances this time is the option configuration. Many times we see a big build up of call contracts at a particular strike price that can serve as an added layer of resistance that most investors won’t see. Here’s how it works.
Most options are written by institutions and they aren’t going to mess around with five, 10 or 20 contracts. An institution is going to write hundreds or even thousands of contracts. Using CVX as our example, if an institution thinks the $125 level is going to hold as resistance, they write thousands of call options at the 125 strike. If the stock moves above the $125 level, the options then have intrinsic value and the institution that wrote them runs the risk of having the stock break out and they could take a big loss.
At present, there are only approximately 8,000 contracts open at the May 125 strike. That is not enough open interest to hold a stock like CVX down. Chevron trades an average of 6.7 million shares per day. The open calls at the 125 strike only represent 800,000 shares.
The sentiment toward Chevron stock is pretty neutral right now. The short-interest ratio is at 2.4, the put/call ratio is at its 49 percentile reading and the analyst ratings show 13 “buy” ratings and 11 “hold” ratings. These are about as neutral as you can get. This could help Chevron stock break through the resistance as investors aren’t overly bullish.
While I think the stock breaks the resistance this time around, if it fails again we could see the stock drop all the way down to $105. However, if I am right and the stock breaks through, the upside potential is huge. Rather than buying the stock and risking a 16% drop or selling it short and risking a breakout to the upside, I would recommend playing a straddle on CVX. I would look at the June 125 strike puts and calls. I say this because the down cycles have taken approximately four to six weeks to play out, so you don’t want to be right and then not give yourself enough time for the cycle to reach its maximum potential.
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