Chesapeake Energy Corporation (NYSE:CHK) reported earnings on Thursday, and Wall Street sold CHK stock down 3%. Chesapeake beat expectations for the most part, but traders found offsetting reasons to worry.
Fundamentally, Chesapeake Energy is not on solid footing. It has internal issues with regards to production and high debt. The company also faces the ongoing hurdles in the energy arena. So to say that CHK stock is a sure bet for longs would be a stretch.
It is noteworthy that most analysts already are realistic with regards to Chesapeake Energy Corporation’s prospects. Most ratings have it as a hold. So the threat of downgrades is low.
Technically, having just lost an important neckline, CHK stock is at risk of further downside even past $5 per share. Trying to catch this falling machete could cost me a few fingers.
Luckily, the options markets allow me to set cautious long CHK positions. The trick is to find levels that are relatively safe and that won’t be breached. The underlying assumption to this trade setup is that the company will survive.
I don’t need Chesapeake Energy to rally; I just need it to not fall more than 30% this year.
How to Trade CHK Stock Here
The Bet: Sell the Jan 2018 $4 put for 50 cents per contract to open. The 30% buffer from current price gives this trade a 70% theoretical chance of success. Usually I like bigger starting buffers for leaps, but in this case, I am banking on the aforementioned assumption holding true.
Selling naked puts is risky and therefore is not appropriate for all investors. I can modify the trade into a spread instead to limit the risk and thereby rendering it more conducive to conservative traders.
The Alternate: Sell the Jan 2018 $4/$3.50 credit put spread. This still is a bullish trade and I still need CHK stock to stay above the same strike sold. But here my risk is finite. I collect 15 cents per contract to open. If successful, the trade would yield 40% on money risked. Both trades have the same theoretical chances of success.
Usually I like to balance my trade by selling opposing risk. In this case, I will refrain from doing so at this time. I don’t like selling call spreads after a sharp drop as I end up selling the trade at a discount. I can add the bearish side if Chesapeake Energy Corporation bounces.
I am not require to hold the trade through expiration. I can close my position at any time for partial gains or losses.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.