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This Stock Completes a Chart Pattern on News

This Stock Completes a Chart Pattern on News

Chart patterns often provide signals at the same time that news develops. That is often the case when earnings are announced.

Business Wire reported,

“Phillips 66 (NYSE: PSX), a diversified energy manufacturing and logistics company, announces fourth-quarter 2019 earnings of $736 million, compared with $712 million in the third quarter of 2019.

Excluding special items of $47 million in the fourth quarter, adjusted earnings were $689 million, compared with third-quarter adjusted earnings of $1.4 billion.”

PSX was down on the news.

PSX daily chart

The news release continued,

“We maintained our strong safety performance and advanced our strategic initiatives during the quarter, but a challenging market environment and turnaround activity impacted our financial results,” said Greg Garland, chairman and CEO of Phillips 66.

“Midstream delivered solid operating and financial performance during the quarter, contributing to record 2019 results for the transportation and NGL businesses.

We continued to execute our major growth projects with the initial startup of the Gray Oak Pipeline and are progressing the Sweeny Hub expansion and the Red Oak and Liberty pipelines. Our Refining and Chemicals businesses ran at 97% utilization.

In Marketing, we formed a new West Coast retail joint venture that will further secure long-term placement of our refinery production and increase our exposure to retail margins.”

“During the fourth quarter, we returned $810 million to shareholders through dividends and share repurchases, and for the year we returned a total of $3.2 billion. Since 2012, we have returned $26 billion to our shareholders and reduced our initial shares outstanding by 33%.

As we begin 2020, we are focused on operating excellence, executing our growth projects, enhancing returns on existing assets and exercising disciplined capital allocation.

We are committed to continued strong shareholder distributions through a secure, growing, competitive dividend, and repurchasing shares when they trade below intrinsic value.”

Refining fourth-quarter pre-tax income was $345 million, compared with $856 million in the third quarter of 2019. Refining results in the third quarter included a $17 million favorable adjustment related to a prior year asset disposition.

Refining adjusted pre-tax income was $345 million in the fourth quarter of 2019, compared with $839 million in the third quarter of 2019. The decrease is primarily driven by turnarounds and lower realized margins.

The decrease in realized margins was due to a decline in 3:2:1 market crack spreads and lower secondary product margins, partially offset by widening Gulf Coast and Central Corridor crude differentials.

Phillips 66’s worldwide crude utilization rate was 97%. Pre-tax turnaround costs for the fourth quarter were $232 million, compared with third-quarter costs of $120 million. Clean product yield was 84% in the fourth quarter.”

The news pushed the stock below important support and provides a price target more than $10 below the recent price.

PSX weekly chart

A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

A Bear Call Spread in PSX

For PSX, we could sell a February 21 $90 call for about $2.55 and buy a February 21 $95 call for about $0.70. This trade generates a credit of $1.85, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $185. The credit received when the trade is opened, $185 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $315. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($185).

This trade offers a potential return of about 58% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if PSX is below $90 when the options expire, a likely event given the stock’s trend.

Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $315 for this trade in PSX.