Brazil filed criminal charges against Chevron (NYSE: CVX) and Transocean (NYSD:RIG) last week, charging the oil companies with negligence in their roles in an oil spill that dumped at least 3,000 barrels of oil on the country's south coast. Since the spill in November, a new leak has been discovered and it is only aggravating the companies' legal woes.
When the criminal charges were announced, Chevron's and Transocean's stocks tanked roughly 2.3% and 2.9%, respectively. Given more news to come related to this oil spill that may negatively affect this stock, investors may consider covered calls as an options strategy to capitalize on the expected volatility in these stocks.
Shortly after the spill, Chevron did take the blame, acknowledging that it did not accurately estimate the pressure of an underwater reservoir that was depositing oil during the drilling process. This led to the oil leak. Although it admitted to the spill, Chevron put the amount of the leak at far fewer barrels - 400 to 650. Transocean is named in the lawsuit because it drilled the well that leaked.
At that time, Brazil filed an $11 billion lawsuit against Chevron and Transocean. Officials also told the companies they could no longer drill in the country.
A main complaint leading to the criminal charges is that Chevron took too long to notify Brazilian government officials of the spill. In addition, the company didn't use the appropriate methods to clean up the spill.
While companies are sued all the time, with little to no affect on their stock prices, Chevron's and Transocean's legal woes are a bit unique in that they involve criminal charges instead of the typical civil charges, regulatory fines and penalties. I doubt that the companies' key executives will be imprisoned as the charges filed by the Brazilian prosecutor demand. However I don't think that this matter will be settled soon.
Immediately after the Brazilian oil spill last fall, Chevron's stock dropped to around $94. Before the spill, it had been trading around $100, rebounding from its 52-week low of about $87.
Before the criminal charges were announced last week, Chevron had been approaching its 52-week high of $112. The day after the charges were announced, its shares were down to about $105.
Transocean had been trading near $60 before the spill, but had dropped to about $43 after the spill. After the charges were announced it was approaching the $60 mark again. It dropped to about $57.
These stocks will continue to fluctuate as the criminal charges make their way through the courts. I believe that during the interim, there will be more news related to the spill's fallout that may adversely affect the prices of these stocks. The possibility of more declines in the value of these stocks make covered calls worth considering. That's because the covered call options strategy can be a good way for investors to protect themselves from a decline in the value of the underlying stock.
The best part of covered calls is that the investor owns the underlying stock rather than buying the option alone. They involve two transactions. First, the stock must be purchased if the investor does not already own it. Next, the investor must sell call options against the stock. He or she is then long the stock and short a call option, creating a covered call.
Covered calls also allow investors the chance to earn additional income from shares of the underlying stock. Let's look at hypothetical examples provided by Born to Sell on covered calls for Chevron and Transocean in which the underlying stock value declines. By the time of the June 16 option expiration date, the investor could receive $276 of option premium income between now and that date. As another example, an investor that owns the same number of shares in Transocean could earn $232 by its May 19 expiration date.
Investors must remember that covered call investing is not meant to get them rich quickly. Key to the investment is the strike price and expiration date. Investors who strategically set the price low enough can make money with covered calls even if the stock price declines, as in the case for Chevron and Transocean. Furthermore, if a stock declines and the investor has a covered call, he or she may lose less than if the investor just owned the stock outright.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.