Around August, traders started pricing in higher oil prices and they had reason to. We had world leaders engaged in nasty war rhetoric. We also had promises of extended and deeper production cuts that are going to include non OPEC members like Russia. There was even the thesis that OPEC needed to prop prices up to benefit the Saudi Arabia Aramco IPO.
The result was a strong rally that brought crude oil to $59 per barrel. ConocoPhillips (NYSE:COP) stock benefited from the rally. On a double bottom late August, COP rallied 25% but it has retraced some back. Technically it still looks vulnerable for more downside but I want to try and catch this falling knife.
No, I will not buy COP stock and hope it bounces so I can profit. Instead I will use options where I sell downside risk into what others fear. I do this while premiums are over-inflated.
The trick is to chose proven support levels where I am willing to own the shares. If the supports hold, then I would have create profits with no money out of pocket.
Fundamentally, I cannot argue for value in ConocoPhillips since it has a negative net profit margin but at a price-to-book of 1.74 I know it won’t be a major mistake to own shares at a discount.
Technically it is not an ideal place to buy the shares because it could still be targeting lower prices. Furthermore, the headlines from the OPEC meeting have been too quiet so perhaps there are snags there and perhaps the production cut deals won’t be as impressive as we are anticipating. Also the Keystone pipeline is coming back online which is bearish for the price of oil.
These circumstances add to the uncertainty of the trade, but as a potential reward I am collecting inflated premiums. If any good news surfaces in the next few weeks then I will get relief and as long as prices stay above my risk level I would retain maximum gains.
Click to Enlarge Experts on Wall Street also expect higher prices from COP stock. It is now trading 18% below the lowest of their price range.
Most analysts have a buy rating on the stock and unless they are all wrong, COP stock should find footing soon enough. That’s all my trade setup needs to win. A rally would be nice but is not necessary.
COP Stock Trade Idea
The Trade: Sell the COP Feb 2018 $44 naked put and collect 65 cents to open. Here I have an 80% theoretical chance that I would retain maximum gains. But if the price falls below my strike then I accrue losses below $43.35.
Selling naked puts comes with big risk especially for an energy stock going into an OPEC production cut decision. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the COP Feb 2018 $44/$42 credit put spread which would deliver over 15% in yield but with much smaller risk. Both set ups have about the same odds of success and neither require a rally to win.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free here. 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 as @racernic on twitter and stocktwits.
