Crude oil has pulled back substantially from the levels it was trading back in May 2012. In response, most of the stocks in the energy sector have taken a drubbing, and some of them are now trading at levels that would make for good long term entry points. One such play is Apache Corp (APA) and a great way to get into this play would be to sell puts on it. There are many benefits associated with selling puts, and many of them are addressed below. One has to have a long term bullish view on this stock otherwise it would be best not to put this strategy into play.
Benefits associated with selling puts
- In essence, you get paid for entering a "limit order" for a stock or stocks you would not mind owning.
- It allows one to generate income in a neutral or rising market.
- When you sell a naked put you are in a way acting like an insurance agent. The seller of the option agrees to buy the stock in the future if it drops to a certain level before the option expires. For this, you (the seller) are paid a premium upfront. If this strategy is repeated over and over again these premiums can really help boost you returns over time.
- Acquiring stocks via short puts is a widely used strategy by many retail traders and is considered to be one of the most conservative option strategies. This strategy is very similar to the covered call strategy.
- The safest option is to make sure the put is "cash secured." This simply means that you have enough cash in the account to purchase that specific stock if it trades below the strike price. Your final price would be a tad bit lower when you add the premium you were paid up front into the equation. For example, if you sold a put at a strike of 20 with two months of time left on it for $2.50, $250 per contract would be deposited in your account.
- Most put options expire worthless and time is on your side. Every day you profit via time decay as long as the stock price does not drop significantly. In the event it does drop below the strike you sold the put at, you get to buy a stock you like at the price you wanted. Time decay is the greatest in the front month.
Suggested put strategy for Apache Corp
If oil continues to trend lower, Apache could test its Oct 2011 lows. The Jan 2013 75 calls are trading in the 5.96-6.10 ranges. We would wait until the stock tests the 79.00-79.50 ranges before putting this strategy into play. If the stock drops to the suggested ranges, these puts should roughly rise in value by another 75 cents to 1.25 in value. For this example, we will take the midway point and assume that these puts can be sold for $6.95. For each contract sold, $695 will be deposited into your account.
Benefits
If the stock does not trade below the strike price you get to walk away with a gain of 9.3% in roughly seven months. If the stock does trade below the strike price and the shares are assigned to your account, you get in at a much lower price. Your final cost will be $68.05 per share.
Risks
The risk is that the shares could be assigned to your account. However as you are bullish on the stock this should not be an issue as you get the chance to get in at a much lower price. If you do have a change of heart, you can always roll the put.
Company: Apache Corp (APA)
Levered free cash flow = $1.82 billion
Brief Overview
- Percentage Held by Insiders = 0.26
- Long term debt to equity ratio = 0.73
- Profit Margin = 24.5%
- Operating Margin = 49.3%
- Quarterly Revenue Growth = 15.5%
- Quarterly Earnings Growth = -29.7%
- Operating Cash Flow = 103M
- Beta = 1.69
- Percentage Held by Institutions = 85.4%
- Short Percentage of Float = 1.3%
- Relative Strength 52 weeks = 35
- Cash Flow 5 -year Average = 20.74
Growth
- Net Income ($mil) 12/2011 = 4584
- Net Income ($mil) 12/2010 = 3032
- Net Income ($mil) 12/2009 = -285
- EBITDA ($mil) 12/2011 = 12297
- EBITDA ($mil) 12/2010 = 8289
- EBITDA ($mil) 12/2009 = 5539
- Cash Flow ($/share) 12/2011 = 23.36
- Cash Flow ($/share) 12/2010 = 17.22
- Cash Flow ($/share) 12/2009 = 21.05
- Sales ($mil) 12/2011 = 16888
- Sales ($mil) 12/2010 = 12092
- Sales ($mil) 12/2009 = 8615
- Annual EPS before NRI 12/2007 = 8.46
- Annual EPS before NRI 12/2008 = 11.61
- Annual EPS before NRI 12/2009 = 5.52
- Annual EPS before NRI 12/2010 = 8.92
- Annual EPS before NRI 12/2011 = 11.93
Dividend history
- Dividend Yield = 0.8
- Dividend Yield 5 Year Average = 0.60
- 5 year dividend growth rate = 1.41
Dividend sustainability
- Payout Ratio = 0.06
- Payout Ratio 5 Year Average = 0.07
Performance
- Next 3-5 Year Estimate EPS Growth rate = 6.41
- ROE 5 Year Average = 17.99
- Return on Investment = 13.83
- Debt/Total Cap 5 Year Average = 21.99
- Current Ratio = 1.10
- Current Ratio 5 Year Average = 1.41
- Quick Ratio = 0.7
- Cash Ratio = 0.22
- Interest Coverage = 19.10
Conclusion
Investors should consider waiting until Apache Corp test the 79.00 ranges before putting this strategy into play. Selling the Jan 2013 75 puts provides investors with the opportunity of getting into the stock well below its Oct 2011 lows. If the shares are not assigned to your account you at least get paid for waiting. Investors looking for other ideas might find this article to be of interest - Are These Dividend Stocks Worth A Closer Look?
Disclaimer
It is imperative that you do your due diligence and then determine if the above play meets with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: EPS and Price vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Earnings and growth estimates sourced from dailyfianance.com.
