The relentless rise in crude oil over the past month has bolstered the performance of energy stocks across the board. Tesoro Corp. (NYSE:TSO) is no exception, as its share price has risen as much as 69% since the October lows alone. However, the recent bout of profit-taking in the refining space has brought TSO to a potential buy point.
The cheaper share price, coupled with option strike prices listed at every dollar interval, makes TSO a prime candidate for put selling. The lower price tag keeps the margin requirement for short puts relatively low, and the multiple strikes available afford us flexibility in structuring a position with the ideal balance of risk vs. reward.
Selling out-of-the-money puts provides a high-probability, limited-reward play if you’re willing to bet that TSO trades sideways or higher from here.
When you’re selling a put option, you know your risk from the outset of the trade — which is that you might be “put” the shares at the strike price. And if that happens, you can either sell your newly acquired shares or, even better, sell covered calls against them for additional option income.
Your potential reward is limited to the premium received at the inception of the trade, and the potential risk is limited to the strike price minus the premium.
At current prices, you can sell the TSO Dec 24 Puts for 85 cents or more. In doing so, you’re essentially betting TSO will remain above $24 by December expiration. In that case, you would capture the entire $85 per contract (85 cents x 100) received at the initiation of the trade.
If TSO ends up falling below $24, traders who ride the trade to expiration will be required to purchase shares at a cost basis of $23.15 ($24 strike – 85 cents premium collected).
In timing your entry, I suggest waiting until TSO rises above a prior day’s high to confirm that a pivot low is forming and a resumption of the uptrend is indeed in the cards.
At the time of this writing Tyler Craig had no positions on TSO.