Crude oil is looking like it has found finally that elusive bottom at the $30 level, especially following comments made by Federal Reserve Governor Bill Dudley regarding the tempering of future Fed interest rate hikes.
With crude charging higher, the fears of dividend cuts had been mostly assuaged, making the attractive yields on the major oil names even more attractive, With the 10-year Treasury yield firmly below 2%, and rates not looking to head higher anytime soon, the yields on Exxon Mobil Corporation (XOM) and Chevron Corporation (CVX) look awfully darn good.
The same could have been said about ConocoPhillips (COP) … until it slashed its dividend by two-thirds amid awful earnings.
With that in mind, it may finally be an opportune time to add some oil stocks to your portfolio, and I think the big three U.S. oil companies — yes, even despite ConocoPhillips’ slip-up — are the safest ways to go.
Just as long as you have the right strategy. Which we do.
Oil Stocks: Exxon Mobil Corporation (XOM)
Exxon stock finally broke out convincingly above the downtrend line, cruising past $76 to close at $79.83 yesterday. Even with the strong rally yesterday, shares of XOM are not close to approaching an overbought level.
Exxon Mobil also sports a healthy 3.7% dividend yield with a fortress balance sheet. Exxon Mobil has upstream, midstream and downstream business integration, which also provides for ongoing and well-diversified cash flow. Just as important, XOM carries the highest investment grade rating by Standard & Poor’s, although the firm was put on review.
Looking out to March, I would position by selling the March $72.50 puts and buying the March $70 puts for a 35-cent net credit. The breakeven point on the trade is $72.15, right at the critical support level of XOM at $72 — a nice 9% cushion from its current price.
The maximum gain on the trade is 35 cents, or $35 per contract, with a maximum risk of $2.15, or $215 per spread. Return on risk is 16.28%.
I would close out the trade on a meaningful break of the $72 support level, while looking to have the spread expire worthless and retain the initial $40 credit if XOM remains well-behaved.
Oil Stocks: Chevron Corporation (CVX)
Click to Enlarge Chevron (CVX) displays a similar technical backdrop to Exxon Mobil, having held support at the $75 level. CVX also pierced through the downtrend line at $82.50, having closed at $84.79.
With a 9-day RSI reading of 51.84, shares of CVX are far from being overbought.
CVX provides a rich 5.1% dividend yield, and has a similarly vertically integrated business model as Exxon. S&P did downgrade Chevron on Tuesday one notch from AA to AA-, which was already mostly reflected in the comparatively higher dividend yield. With oil having rebounded 8% since the downgrade, the fear of additional downgrades has greatly diminished.
Again looking out to March, I would position by selling the March $75 puts and buying the March $72.50 puts for a 45-cent net credit. Breakeven is at $74.55, 11% below current prices and just below critical support at $75. This reflects the relatively more perceived risk in Chevron versus Exxon Mobil.
The maximum gain on the trade is $45 per spread, with the maximum risk of $205 per spread. Return on risk is 21.95%.
I would close out the trade on a meaningful break of the $75 support level, while looking to have the spread expire worthless and retain the initial $45 credit if CVX remains well-behaved.
Oil Stocks: ConocoPhillips (COP)
Shares did finally break the downtrend line at $35 as well, closing at $35.32 following an ugly earnings report. The 9-day RSI reading of 38.77 is decidedly neutral.
It’s interesting to note the still-elevated levels of implied volatility in COP compared to the other two names even after earnings — usually a good contrarian indicator as well.
ConocoPhillips sported a too-good-to-be-true yield approaching 8% … right up until Conoco slashed its dividend by two-thirds, as Credit Suisse hinted at earlier. Now, COP shares yield 3%. The company also has initiated a major cost-cutting effort to help maintain cash flows during a difficult time in the oil patch.
Once again looking out to March, I would position by selling the March $31 puts and buying the March $29 puts for a 45-cent net credit. The breakeven point on the trade is $30.55, well below the recent support level of COP at $35 and also below the intraday low of $32.71 from January 20. All told, this breakeven point is 8% below current prices, so again, a decent downside cushion.
The maximum gain on the trade is $45 per spread, with the maximum risk of $155 per spread. Return on risk is 29.03%.
I would close out the trade on a close below $32.71, while looking to have the spread expire worthless and retain the initial $45 credit if COP remains well-behaved.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at firstname.lastname@example.org.