A Quick 43% Return With This Chevron Trade

Google+ Pinterest LinkedIn Tumblr

With slowing consumer confidence, ongoing trade wars and overall economic slowdown around the world, it’s no surprise oil prices have been in the basement of late.

Screen Shot 2019-09-03 at 2.02.44 PM

After a first half of 2019 rally, these economic pressures have been slowly forcing oil down. China’s latest round of tariffs include a 5% rate on all U.S. oil, which certainly doesn’t help.

Still, the industry isn’t as dead as all of this makes it seem. Share performance has reflected oil prices, but oil company’s financial performances have been much better.

Chevron (CVX), in particular, has done much better than its stock chart shows:

Screen Shot 2019-09-03 at 2.02.51 PM.png

During its most recent quarter, the company performed about how analysts expected after factoring in the $1 billion bonus the company received from dropping out of its acquisition campaign for Anadarko Petroleum.

Investors have been short sighted when it comes to this performance. Not only are they missing the key performance results. But they are also ignoring the steps Chevron have taken to grow despite weaker oil prices.

Experts expect that oil will remain down for the rest of 2019, but to surge in 2020. Whether or not that’s true, Chevron has been making efforts to increase upstream production, particularly at its Permian Basin sites, to offset any price fluctuations. Already, this is paying off.

In this most recent quarter, total production increased 9% compared to the same period last year. That kind of jump didn’t happen on its own. And it should continue.

Chevron can keep pouring money into this production boost simply because it has so much of it. Unlike Exxon, which has seen its cash flows turn negative with current oil prices, Chevron’s margins have held. It can still easily cover capex and its dividend going forward… even if prices slump further.

And we can’t forget that dividend either. Investors certainly won’t in coming weeks and months. As the search for yield picks up steam – with none to be found in fixed income and most other stocks – Chevron’s 4% dividend yield will be a hot commodity going forward.

None of this is to say that Chevron is a stock you should hold for years and decades. But the market’s recent punishment is certainly a step too far. Just consider its price tag.

Right now, even after the effects lower oil prices have had on the company, it still trades at 15.3 times its earnings… 14 times its forward earnings. That’s around a 20% discount to where it has historically traded.

This presents us with a great short-term opportunity to front run both those income seekers and the inevitable return to norm in valuation.

Of course, you could simply buy shares of CVX and wait for that bump to happen. But that would likely only result in a few percentage points over time for a large investment.

Through one of our favorite strategies, we have a better way to play this idea.

A Strategy For Short Term Bulls

Knowing that a stock is set to rise and inevitably do so doesn’t mean it will happen overnight. And for CVX, its trading ties with the price of oil could result in a much longer time horizon for its return to norm.

That’s why smart traders should consider using a bull put spread strategy.

The way this kind of trade works is by selling a put option on a stock you believe is either set to grow or at least not fall. Then you buy a second put with a lower strike price. We’ll get into a specific example in a moment.

The idea behind this move is to collect the income from the sold put, just like selling naked puts or cash-secured puts… but then protecting your downside by buying that lower-strike insurance put.

You can see here that the strategy results in a limited risk, limited reward opportunity:

Source: The Options Industry Council

However, just because the profits are capped, doesn’t mean they aren’t large… and easily achievable.

In fact, for a trader to max out his profit with this trade, the underlying stock doesn’t even have to bounce higher as expected. It can trade flat throughout the whole trade and the trader would still maximize his profits.

Let’s look at a specific example to show you what we mean…

A Specific Trade on CVX

Right now, a trader could sell an October 18 $115 put on CVX for $3.15 per share and buy an October $110 put for $1.65 per share for a net credit of $1.50 per share. Since each contract is worth 100 shares of CVX, that’s an immediate income of $150 to open this trade.

That $150 hits the trader’s account the minute his orders go through. It is also his maximum profit potential for the trade.

It’s his to keep as long as shares of CVX don’t fall below $115 by October 18. And considering that they should actually rise in this period, despite all else in the market, that’s more than likely.

This kind of trade does come with some risk, however. Income is never free. To find how much the trader has at risk, take the difference in strike prices ($115 – $110 = $5), and subtract the income received ($5 – $1.50 = $3.50). On 100 shares that’s $350 at risk. However, the only way for the trader to lose that would be if shares tanked down below $110 over the next month and a half.

This essentially means that the trader is looking at a 43% return on his amount at risk for a six-week trade. And since shares of CVX don’t have to even return to their historical norm to collect every cent of that return, that makes this trade a no-brainer.

Write A Comment