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I have been a long-time holder of ConocoPhillips (NYSE:COP) and, consequently, after the breakup of the company I am now also a holder of Phillips 66 (NYSE:PSX). On May 1, COP broke off into two different companies. After this split, shareholders of COP at the time were granted one-third the value of their COP stock in PSX shares. This split has received mixed reviews, and the discussion as to which company is the better value is still up for debate. In Berkshire Hathaway's (NYSE:BRK.A) most recent earnings announcement, the company announced that it intends to divest its COP shares and plans to keep its PSX shares. I find this to be an interesting move, especially since I feel that COP is the better value of the two companies.

After the split, COP remains involved in the exploration and production of oil and gas products, while PSX took on the production of natural gas liquids and the petrochemicals components of the company. Even after the split, both COP and PSX continue to remain in direct competition with larger oil companies such as Exxon Mobile (NYSE:XOM), Chevron (NYSE:CVX), Royal Dutch Shell (NYSE:RDS.A), Total (NYSE:TOT), Occidental Petroleum (NYSE:OXY), and BP (NYSE:BP).

In COP's most recent earnings release, the company reported $1.22 EPS for the quarter, missing the average estimate of $1.28. Total production fell to 1.54 million barrels of oil per day, down from the 1.64 million barrels a day in the prior quarter. Even with this being the case, I still believe that COP is the better value compared to PSX. To help better illustrate this, below is a chart that compares some of the core fundamentals of the two companies.

COP

PSX

Market Capitalization

$69.65 billion

$25.03 billion

EPS

5.18

7.68

P/E

11.08

5.20

Book Value

$37.85

$30.22

Dividend Yield

$2.64/4.63%

$0.80/2.00%

Profit Margin

11.57%

2.47%

From a valuation and overall potential for higher returns standpoint, I feel that COP is the better choice of the two companies. COP has a higher profit margin as well as overall book value and market capitalization. Unfortunately, the market continues to undervalue COP compared to PSX, regardless of the fundamentals. Even though COP's price in recent weeks (along with the rest of the market) has done well, I feel that there are a number of external factors that could begin putting additional downward pressure on COP in the coming weeks.

  • As Berkshire Hathaway starts selling its COP shares, Buffett's followers will begin to follow suit. These followers seem to mimic his every move regardless of what he does. This mass selling effect will cause the stock to trade lower.
  • The European crisis continues to linger on through the end of the year. That will increase the threat of further global slowness, which will continue to hurt global economic activity as well as drag down oil/natural gas prices.
  • The increasing uncertainty with the U.S. political scene continues to play a role in how the market prices in the future, and what effect the new president/Congress will have on potential new regulations and taxes.
  • As the fiscal cliff draws nearer, the fear of another downgrade or possible recession continues to hang on stock and commodity prices.

Just one of these factors alone could further hurt the price of COP, not to mention the effect of several of them happening simultaneously. Once the selling pressure begins it will be tough to know when it will end, but on the bright side once the selling does begin I think that it will create an excellent buying opportunity for anyone interested in holding COP at an excellent price.

As the price of COP begins to decline, traders really have two choices: They can start buying the stock outright at market price and hope to dollar cost average down, or they can sell some cash secured puts at strike prices that seem to be at favorable purchase price points. COP currently trades for around $57 per share, which is roughly trading at its 52-week high of $57.10. At its current price, COP trades for 11 times earnings with a dividend yield of 4.64%. I prefer to sell cash secured puts as a way to initiate a position in this stock because it allows a trader a way to pick his or her entry point as well as get paid either way. If the put contract(s) are put to the trader, the premium received can act as a discount toward the total purchase price. When looking at COP's put option contracts, they are priced in $2.50-per-share increments. Based on the current market price, I would be a buyer of the January COP contract at the $55, $52.50, and $50 strikes.

To do this, I would suggest selling some type of combination of the three contracts depending on how much COP stock the trader would be interested in buying and at what price. Personally, I am interested in taking on 500 shares of COP, so I will make my example reflect that assumption. I would suggest selling two January $55 strikes for $2.75 (5% discount), one January $52.50 strike for $1.90 (3.65% discount), and two January $50 strikes for $1.40 (2.80% discount). This would leave the trader with a total net credit of $1,020. This would be a 3.88% of the total value of the 500 shares if (or when) the trader was put to the stocks. This trade obligates the trader to a total COP share cost of $26,250 with an average stock price of $52.50/share. If you subtract the premium that is received for doing the trade (assuming that all three contracts were put to the trader), the net cost would be $25,230, with an average stock price of $50.46/share.

In order to be put to all three of these separate COP contracts, the stock would have to be at or below $50/share on expiration Friday, which is Jan. 18, 2013. This would also mean that COP had decreased in value by 12.35% in value based on its current market price. Below I have outlined all of the possible outcomes of this trade and what the net cost to the trader might be.

  • COP stays above $55 per share between now and Jan. 18, 2013. The put options expire worthless and the trader gets to keep the entire $1,020 that was received for doing the trade.
  • COP drops below $55 per share, but stays above $52.50 per share between now and Jan. 18, 2013. The two $55 strike options are put to the trader and they are forced to buy 200 shares of COP at $55 per share. The premium from the other two contracts is kept as the options expire worthless. The net cost of owning the stock is $9,980, or $49.90 per share.
  • COP drops below $52.50 per share, but stays above $50/share between now and Jan. 18, 2013. The trader is forced to buy 200 shares of COP at $55 and 100 shares at $52.50, this creates a breakeven at $54.16 per share. The option premiums are kept and help further offset the purchase prices. The net cost of owning the stock becomes $15,230, or $50.76 per share.
  • COP drops below $50 per share between now and Jan. 18, 2013. All three option contracts expire in the money and the trader is put to the $55, $52.50, and $50 option contracts, with an investment breakeven of $52.50 per share. All of the premiums are kept and create a net cost of owning the stock of $25,230, or $50.46 per share.

This trade can be done with any combination of COP strike prices based on the trader's risk tolerance. It is important to remember that as the price continues to decrease the dividend rate increases and the earnings multiple decreases, which in turn creates greater value for the trader. I like this trade and feel that it allows the trader to capitalize on the increased volatility created by selling pressure in COP, while still allowing the trader to dollar cost average.

Disclosure: I am long COP, PSX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Buying ConocoPhillips With Cash Secured Puts