This large cap energy stock has been hit from all angles, ranging from low oil prices, to fossil fuel campaign divestment selling pressures, and now a threat of decreased short-term demand from coronavirus impacts. However, it still generates a ton of cash flow, it has a lower break even cost than many peers, and long-term demand simply is not going away (much to the chagrin of many ESG investors). What we’re left with is a big safe dividends, and very high upfront income in the options market courtesy of the recent bout of heightened fear and volatility. We believe the trade highlighted in this article is an attractive one to place today, and into early next week, so long as the underlying stock price doesn’t move dramatically before then.
The Trade:
Sell Put Options on Exxon Mobil (XOM) with a strike price of $55 (6.5% out of the money), and an expiration date of March 20, 2020, and for a premium of $0.32 (this comes out to +7.0% of extra income on an annualized basis, ($0.32/$55 x (12 months, annualized). This trade not only generates attractive income for us now, but it gives us the possibility of owning shares of XOM at an even lower price if the shares fall even further than they already recently have, and they get put to us (and we’d be happy to own XOM, especially if it falls to a purchase price of $55 per share).
Note: If you’ want higher upfront income, and a higher chance of having the shares put to you, consider selling the $57.50 put instead.
Your Opportunity:
We believe this is an attractive trade to place today and potentially into early next week as long as the price of XOM doesn't move too dramatically before then, and as long as you’re able to generate annualized premium (income for selling, divided by strike price, annualized) of approximately 7% to 10%, or greater.
Our Thesis:
Our thesis is basically that XOM generates a ton of cash, it pays a big safe dividend, its break even production cost is lower than many peers, and its product will remain in high demand for decades to come (i.e. alternative energy sources will unfortunately not be mainstream for decades). However, there continues to be a slew of bad press that has caused fearful investors to sell, thereby driving the price too low relative to the value of the business (plus it’s also mathematically driven the dividend yield even higher and more attractive). You can read our recent full report on the attractiveness of XOM here:
Also important to note, we already do own shares of XOM, and we wouldn’t mind owning more (for the long-term) if the price falls even further than it already has and the shares get put to us.
Please also keep in mind, options contracts trade in lots of 100, so to secure this trade with cash (in case the shares get put to you and you have to buy them) you’ll need to keep $55 times 100 on hand (the strike price times an options contract lot of 100). You’ll also need to be comfortable holding that many shares in your account from a position-sizing / risk management standpoint.
Important Trade Considerations:
Two important considerations when selling put options are dividends and earnings announcements because they can both impact the price and thereby impact your trade. In this particular case, they are both largely a non-issue because XOM won’t announce again after this contract expires, and it won’r go ex-dividend again until May (also well after this contract expires). Had either of these events been scheduled for before this options contract expires, we’d need to be comfortable with the added risks (i.e. we’d need to receive more upfront premium income on the trade).
Conclusion:
XOM is an attractive, big-dividend, energy company that has been experiencing way too much selling pressure (in our view) due to the overblown near-term fears and fossil fuel divestment publicity. We view it as an attractive opportunisty to “be greedy when others are fearful.”
As noted earlier, in our full XOM report, we view XOM as presenting an attractive long-term investment opportunity at its current price, however if you’re uncertain about pulling the trigger on a normal buy order, you might consider this trade instead. It allows you to generate attractive upfront income that you get to keep no matter what. And this options trade also gives you a chance of picking up shares of this attractive long-term blue chip company at an even lower price, if the shares fall even further than they already have, and they get put to you at $55. And at a price of $55, XOM is an extremely attractive long-term cash flow generator.
For further reference, be sure to check out our:
Portfolio Holdings Tracker Tool.