Shares of ConocoPhillips (NYSE:COP) have certainly been gushing lately. COP stock has been by far the best-performing major U.S oil stock in 2018, gaining as much as 45% year to date. The rally, however, is starting to look a little tired on a fundamental, comparative and technical basis. Expect COP stock to have trouble heading higher over the coming weeks.
Conoco is getting rather pricey on a valuation basis. The current price-to-earnings ratio of is now over 21 and nearly 50% higher than the five-year average. Other metrics, such as price to book and price to cash flow, show similar levels of comparative overvaluation. The dividend yield, which used to be a hallmark of COP stock, now sits at just 1.4% and is at a discount to the 1.8% yield on the S&P 500. The price-to-sales ratio of 3 is now at the highest level in the past 10 years.
Conoco Phillips is certainly not a cheap stock at current levels.
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COP stock is overextended on a comparative basis. Conoco is the third-largest component of the Energy Select Sector SPDR ETF (NYSE:XLE), with COP normally highly correlated to the XLE. This correlation has broken down recently, however, with Conoco being a dramatic outperformer. A look at the weekly chart shows this huge divergence. I expect COP stock to revert to the mean and be a relative underperformer over the coming months.
The technicals also point to a pullback in COP stock. Shares have added nearly 14% since making lows near the $70 level in early September. The 14-day RSI reached overbought readings that have signaled short-term tops in the past.
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Conoco is also trading at a big premium to the 50 day moving average which inevitably lead to a retracement over the past year. COP stock had an inside day yesterday, meaning that the entire price range fell within the price range of the previous day. This is many times a reliable indication that the trend may be coming to an end.
Implied volatility (IV) in COP options is currently at the 37th percentile, meaning option prices are fairly cheap. So to position for a pullback in COP stock, a put diagonal spread trade makes probabilistic sense.
COP Stock Trade Idea
Buy the COP Nov $77.50 puts and sell the COP Oct $76 puts for a $1.65 net debit.
Maximum risk on the trade is $165 per spread. Ideally COP stock closes near $76 at October expiration to realize the maximum gain. The trade is 16 deltas net short at inception — the equivalent of being short 16 shares of COP stock.
Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility.
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