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Morning Update

Yesterday refining stocks plummeted after Valero said it expects to pay $300-$400 million to comply with cleaner gasoline requirements expected to be in effect by 2017. This sent a wave of selling through the refining sector as traders, worrying over margins, heavy maintenance ahead of the summer driving season, and the expenses related to the new emissions regulations took the opportunity to take profits in these names. Options volume in Phillips 66 has been heavy the last two days and focused on defensive trades. One of the biggest trades yesterday was the purchase of 1000 April 65 puts for $0.65 with the stock at 67.85, This morning those puts were sold for $2.35 with the stock at 63.93. This trade risked $65,000 in options premium and turned a profit of $170,000 in one day.

The take away from this trade for long term investors who are long the stock should be that these option traders have already switched from buying puts to selling them. This shows they think this move, which looks quite panicked, is overdone and due to reverse or at least fizzle out. The selling in these names is due to the fact that because they have had such a great run higher in the past few months most traders have large gains on their books. Now that they have down ticked those traders are selling to protect their profits while they wait for more certainty on the situation going forward. If you are a longer term investor consider instead selling calls against the stock to cushion the downside and take advantage of the spike in implied volatility. Similarly for traders who don’t have a stock position but want to buy the dip consider selling puts at a level you would be happy to own the stock. This strategy lets you take advantage of the spike in implied volatility and can produce income and possible a great long term buy entry into the stock.

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