Chesapeake Energy Corporation (NYSE:CHK) has managed to astound many Wall Street participants as its conditions have somehow gone from bad to worse, both on and off the price chart. For as troubled as CHK stock has been, there always seems to be more bottom.
Today, I have a trade that we can use to harness Chesapeake’s pain … without going into massive debt like CHK.
Since writing about Chesapeake Energy stock in late April, it has been increasingly tough to justify owning the natural gas and oil outfit. In fact, I suggested a limited-risk strategy in lieu of shorting shares. And guess what? Chesapeake is in even worse shape now.
Chesapeake’s most recent corporate confessional in early May did offer up some improvements. But it’s our understanding that egregious debt versus operating cash flow has only worsened. Between that and continuing deterioration in the energy market, CHK stock looks susceptible to even more failure.
Chesapeake’s Stock Chart
Click to Enlarge Over the past couple months, CHK has moved from a bullish technical profile (defined by a stable-looking up-channel) to a much more bearish-looking situation.
A breakdown of the uptrend in February followed by a flag-style failure in early April has resulted in a bearish lower high. Chesapeake now sits near its range lows of the past three months.
Not helping is a bearish crossover in the weekly stochastics and neutral reading, supporting our technical view that the trend in CHK stock is pointed lower.
I will point out that a potential triple bottom that has developed since the March low could offer technical support. So far, the formation has held the 50% retracement level from Chesapeake’s February 2016 low to December 2016 high. You could call this triple bottom the “real” bottom line.
But I believe this support will ultimately fail and lead to a price move toward $4 and the 62% retracement level.
How to Trade CHK Stock
Back in April, I offered up a long put butterfly position to take advantage of our bearish stance, believing Chesapeake Energy would be under increasing technical pressure. The May $6/$5/$4 put butterfly was priced at 33 cents, and at its best the spread increased in value by 67% to 55 cents before eventually expiring for 22 cents.
I still like this strategy, but now that I think technical support will buckle, the Aug $5/$4/$3 put butterfly is more in line with our outlook.
This butterfly is priced at 25 cents with CHK stock at $5.10. It targets the $4 level and the 62% retracement level, with the potential for 75 cents in additional cash flow, so a return of 300%.
More realistically, this spread opens up a nice profit range from $3.25 to $4.75. Given that maximizing the spread value in a slightly longer-dated butterfly is a slower process, you could take partial profits on a double should CHK cooperate with our forecast.
If this spread drops by more than 50% in value, exit this strategy.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.