Bundle Up With an Energy Options Play

Advertisement

Most parts of the country know that the days of using your air conditioning are most likely over, and it’s time to have your furnace checked. The cold weather is coming, and you need to be prepared.

The same can be said of your portfolio. Many so-called “experts” have said that the current bullish run will most likely stall. Whether you believe them or not, it’s always prudent to be selective in your investments. This trade idea might just make you feel all warm and fizzy inside — even in the cold weather:

Cabot Oil & Gas (NYSE:COG) is an independent oil and gas company engaged in the development, exploitation and exploration of oil and gas properties exclusively in the continental United States.

Natural gas prices have been rising recently primarily as fears of running out of storage capacity are no longer an issue. COG has about two-thirds of its rigs focused on natural gas drilling and is No. 2 in production growth in the lower United States. The company also is well-positioned to capture rising natural gas prices because they are concentrated in two of the best natural gas areas in the country: Marcellus and the Pearsall Shale.

For the past three months, Cabot Oil & Gas has moved slowly from around $38 to $43, where it currently is trading. The stock just recently set its all-time high and was unable to close above $46. Currently, COG is pulling back, giving investors a chance to buy it at a cheaper price.

COG$43.82

Example: Buy 100 shares of COG @ $43.82 and sell the October 46 call @ 50 cents.
Cost of the stock: 100 X 43.82 = $4,382 debit.
Premium received: 100 X 0.50 = $50 credit.
Maximum profit: $268 — that’s $218 (46 – 43.82 X 100) from the stock, and $50 from the premium received if COG finishes at or above $46 @ October expiration.
Breakeven: If COG finishes at $43.32 (43.82 – 0.50) @ October expiration.
Maximum loss: $4,332, which occurs in the unlikely event that COG goes to $0 @ October expiration.

Trade Management

The best-case scenario for a covered call strategy is for the stock to just rise up to the sold call’s strike price at expiration, which in this case is $46. The stock moves up the maximum amount without being called away, and gains are enjoyed on the shares and the option premium. Then the process can be duplicated for the next expiration if so desired.

The 46 strike was chosen based on the resistance the stock has encountered at that price level. If COG rises faster than anticipated and past the $46 strike before October expiration, an adjustment can be implemented. The call option can be bought back/ and a higher strike can be sold against the position to avoid assignment. This will allow the stock to remain in the portfolio and also give the position a chance to increase its return if stock moves higher.

If the stock drops in price more than was anticipated, it might make sense to close out the entire trade (stock and short call) to possibly avoid further losses.

As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2012/10/bundle-up-with-an-energy-options-play/.

©2024 InvestorPlace Media, LLC