Canadian integrated oil & gas major Suncor Energy (NYSE:SU) looked pretty cheap before it got taken to the woodshed Thursday for a 7.4% flogging. After all, since Feb 24 when SU traded at $36.96 it has sold off 27.2% all the way down to $26.91. Not to mention the 43.6% Suncor is down since it traded at $47.73 on March 4th of last year. Or the 62.2% since May 23 2008. Suncor Energy was a $100+ billion dollar company. Now it wallows around $42 billion.
Suncor is nearing the 2008 crash neighborhood. How many times have we looked at those 2008 lows on charts and wished that was where we had gotten in? Here's a stock that could be giving us a chance. Look at all those little blue dividend flags too. Suncor raised its dividend 3 times while its stock got drawn and quartered. Drawn and thirded anyway.
What to Do
To be clear we are not advocating making this trade. Instead we want to do a simulation trade to see what our fate would have been if we had made the trade and what we can learn along the way.
So supposing we think that Suncor is due for a nice jump. Let's say we think SU will reclaim about two-thirds of the 27.2% it has lost since February, and we think this will play out over the rest of 2012.
Let's also suppose that we like money, and we do not like losing money. Suncor itself has proven that cheap stocks can just get cheaper, so we want to risk as little money as possible to get exposure up to about a 20% rise in the price. What we want is a bull call spread (that would be a great name for a financial singles bar).
The Bull Call Spread
The bull call spread is for more than finding love though, it is for finding limited upside exposure to a stock at a discount. Let's have a look at the options chain for Suncor. (Source: ETrade)
SU trades at $26.91 right now. That $32 call is 18.9% above the current price so that looks like a good target price for us. So here's the idea. We will buy a call on Suncor to get exposure that is cheaper than common stock, and further we will sell a call with the same expiration but a higher strike. This will cut off our upside, but it will also help to finance the trade, making the call we bought cheaper. We will buy a call at right around where Suncor currently trades, $27. This will give us the upside exposure of 100 shares of Suncor at the asking price of $310. Compare that to the $2,691 we would spend on 100 common shares. We will also write(sell) a call. If we write that $32 call then we get the $118 bid price for it. This effectively cuts off our upside exposure at $32, but it also cuts our total risk from $310 to $192.
So let's see, if SU goes to $32 this year, then both 100 shares of the common stock and this bull call spread will profit about $500. OK. Now how about if Suncor goes to $0? The common stock loses $2,691. Ouch. The BCS though loses only the original $192. Rock on.
Cheap stocks can surge fast, but cheap stocks can also keep getting cheaper. Fast. Trying to time a bottom in a stock can result in catching a falling knife and the bull call spread is a great way to limit risk while still capturing the first part of an upside move. We will name this trade the "Bull Call Love" trade and we will monitor its progress to see what we can learn along the way.
With so many energy names being beaten down recently consider a bull call spread in lieu of owning common stock on these energy sector names: Arch Coal Inc (NYSE:ACI), Alpha Natural Resources, Inc. (NYSE:ANR), Apache Corporation (NYSE:APA), Baker Hughes Incorporated (NYSE:BHI), Peabody Energy Corporation (NYSE:BTU), Chesapeake Energy Corporation (NYSE:CHK), ConocoPhillips (NYSE:COP), Chevron Corporation (NYSE:CVX), Devon Energy Corporation (NYSE:DVN), Enbridge Energy Partners, L.P. (NYSE:EEP), EOG Resources, Inc. (NYSE:EOG), Halliburton Company (NYSE:HAL), Hess Corp. (NYSE:HES), Linn Energy, LLC (NASDAQ:LINE), Marathon Oil Corporation (NYSE:MRO), National-Oilwell Varco, Inc. (NYSE:NOV), Plains All American Pipeline, L.P. (NYSE:PAA), Petroleo Brasileiro SA (ADR) (NYSE:PBR), Penn West Petroleum Ltd (USA) (NYSE:PWE), Royal Dutch Shell plc (ADR) (NYSE:RDS.A), Seadrill Ltd (NYSE:SDRL), Schlumberger Limited. (NYSE:SLB), Statoil ASA (ADR) (NYSE:STO), Suncor Energy Inc. (NYSE:), TOTAL S.A. (ADR) (NYSE:TOT), Valero Energy Corporation (NYSE:VLO), Exxon Mobil Corporation (NYSE:XOM)
Disclosure: I am long ACI.