Technical analysis isn’t everyone’s cup of tea, let’s just get that out of the way. Too often, the discipline can devolve into seeing whatever the trader wants to see, which then raises questions about the objectivity of the practice. However, a solid argument exists that when the technical approach combines with the tried-and-true fundamental framework, this combined methodology can be quite powerful.
That may be the case with EOG Resources (EOG). A company primarily involved in the upstream component of the hydrocarbon energy business — that is, exploration and production — EOG stock was poised to face some inquiries had Vice President Kamala Harris won the 2024 presidential election. However, Donald J. Trump pulled off the comeback for the ages, thereby shifting the paradigm for the fossil fuel industry.
With Trump basically adopting a “drill, baby, drill” mentality, EOG stock should theoretically perform well in the coming administration. What’s more, the company has produced strong results, generating earnings of $1.67 billion for the third quarter. On an adjusted per-share basis, earnings came out to $2.89 per share, exceeding Wall Street’s estimate of $2.73 per share.
At the same time, the J-Pattern or J-Hook indicator — one of the top quantitative technical signals provided by Barchart Screeners — flashed brightly on Thursday, suggesting a possible upside opportunity.
Investigating the J-Hook for EOG Stock
One of the key advantages of the J-Hook is, again, the quantitative nature of the signal. Unlike typical chart patterns, programmers can deploy algorithms to mathematically capture the materialization of the distinctive J-Pattern. As I mentioned in my article last week, below is the basic anatomy of the indicator:
- Initial uptrend: The target security experiences a strong upward movement.
- Pullback/consolidation: Following the initial rise, the stock encounters a brief pullback or sideways consolidation phase.
- Rebound and breakout: After this consolidation period is over, the security begins to rise again, forming the “hook” component of the J-Pattern.
If the implications of the J-Hook hold true, EOG stock should swing higher soon. With the market responding enthusiastically to the incoming Trump administration and the potential for business-friendly policies, it wouldn’t be surprising for EOG to jump northward. Plus, Trump is a proponent of fossil fuels, which should be directly beneficial for the oil and gas producer.
Deploying a Bull Call Spread for an Extra Kick
For the most conservative approach, an investor could simply buy EOG stock in the open market. However, if you happen to believe in the predictive potential of the J-Hook, you may want to consider a strategy — more like a tactic — with extra kick. If that’s you, you might want to consider a bull call spread.
You can think of this trade as buying a call option on discount. First, you’ll buy a call of your choosing. Second and at the same time, you’ll sell a call at a higher strike price. The gross credit (income) received from the short call will help defray some of the debit paid of the long call.
With this transaction, you will have a trade featuring capped rewards and capped downside. On the positive end, you cannot lose more than the net debit paid to enter the trade. However, on the flipside, your return (payout) is capped at the reward received when the security hits the short (higher) strike price. Any movement upward beyond the short strike is an opportunity cost.
However, if we pick an options chain that’s very close to expiration, the capped reward may not be that big of a deal. In other words, there’s simply not enough time for the security to rocket to the moon. With that in mind, in a bull call spread, investors can choose a strike-price combo that is more realistic in terms of profitability potential.
Using Science to Narrow Down the Spreads
With a Barchart Premier membership, traders can drill down on all the available options trades for their target expiration date. Needless to say, it’s a timesaver. In addition, the ability to download these datasets enables us to conduct nonlinear pricing optimization to better determine which spread or spreads make the most sense.
Essentially, a vertical spread like the bull call spread is an insurance policy: you’re paying for the coverage of expected share price movements. You can widen this coverage and improve the chances of success. However, doing so will grossly limit your payout because you’re paying extra premium for the safety margin. Further, if this margin turned out to be unnecessary, you absorbed an opportunity cost.
Therefore, the goal of any multi-leg options trade is to maximize the return (or yield) while minimizing the risk. Based on a modeling that I used to account for the multi-variate nature of risk (i.e. the combo of cash at risk and the likelihood of profitability), I calculated that the 134/137 call spread — for the options chain expiring Nov. 22 — is a solid baseline trade.
With this transaction, you’re putting $165 at risk to potentially earn $135, for a maximum payout of 81.82%. Further, the gap to breakeven is only 0.34%, which is very reasonable if you’re bullish on EOG stock.
However, for the true daredevil, the 135/138 call spread is incredibly enticing. By putting $135 at risk, you could earn a maximum of $165 or a payout of 122.22%. What’s more, the gap to breakeven here is only 0.86%. And EOG stock needs to move up by about 2.1% to hit the maximum payout, which is challenging but not impossible based on the market’s expected movement.
