Energy is in worst month since 2011, and more pain could be ahead

Energy is in worst month in seven years, and more pain could come

Energy stocks have been punished this month.

The sector has bottomed out the in December, falling more than 13 percent, in its worst month since September 2011.

TradingAnalysis.com founder Todd Gordon says years of underperformance in the XLE energy ETF against the S&P 500 have made the sector susceptible to greater swings to the downside.

"The 2015 sell-off came, both markets were hit," Gordon said of the S&P 500 and XLE on CNBC's "Trading Nation" on Thursday. "As the S&P eventually found its footing, it broke to new highs here but you'll notice that the XLE also started to recover off the lows but did not come close to eclipsing the 2014 high, a major warning sign."

The S&P 500 hit a record high as recently as September, while the XLE ETF has not reached its own since June 2014.

"Just clear underperformance here in the XLE, now no surprise as the volatility has really started to pick up, the XLE is really coming under a lot of pressure as crude oil is falling quite sharply," he added.

The XLE ETF has tumbled 22 percent this year, and West Texas Intermediate crude oil has slumped 25 percent.

"What we're going to do is connect the lows from 2008 and then to 2011, and that breakdown is going to be right around $56, and that's going to begin the entry on our trade," said Gordon.

The XLE ETF is closing in on $56 after tanking 9 percent this week. It is roughly a 1 percent drop from reaching that level.

"If we were to break that uptrend line … over here on the daily chart, there's no reason that we shouldn't be able to go down and retest this 2016 low at about $50," said Gordon. "I'm not calling for an all-out collapse here. Let's just take one leg at a time, set up a put spread in order to take us down to that significant low and again potentially break that trendline that has been in place since 2008."

A decline to $50 would represent a 12 percent drop from current levels. Such a move would be a 37 percent slump from its 52-week high set in May.

To take advantage of a move to the downside, Gordon suggests buying a put spread. Specifically he's looking at a purchase of the Feb 55/50 put spread for $0.96 per options contract. This a bearish bet that the energy ETF could fall down to $50, or more than 3 percent from its current levels, by February expiration.