The strategy of selling a put to purchase calls provides you with the opportunity to leverage your position in Marathon Oil (MRO), and the chance to get into the stock at a much lower price. Only put this strategy to use if you are bullish on the prospects of this stock as there is a chance that the shares could be put to your account. Before we get into the details of the strategy, we are going to provide investors with some reasons to consider Marathon.
The company has disposed of assets that do not fit into its long-term growth plan. In the past five years, it has sold roughly $3.5 billion worth of non-core oil and gas properties. This has helped it free up capital and focus on its longer term high growth prospects. It plans to get rid of an additional $1.5-$3.00 billion of assets by 2013.
Marathon Oil has a strong inventory of projects in the developmental stage in areas such as Indonesia, Iraq (Kurdistan section) and Poland. These projects should enable management to maintain and most likely surpass their guidance for 6.8% annual production growth rate for 2012 and 2013
The completed acquisition of acreage in the Eagle ford shale formation in South Texas from Hilcorp Resource holdings, offer it an important production growth opportunity in the high margin North American unconventional resource plays.
Additional Reasons to be bullish on Marathon Oil Corporation
- A low payout ratio of 26%
- A free cash flow rate of $2.66 billion
- A good operating margin of 33%
- A very strong interest coverage ratio of 30
- A great retention ratio of 74%
- A decent dividend rate of 2.2%
- Net income has risen from $1.4 billion in 2009 to $2.9 billion in 2011
- Annual EPS before NRI rose from $1.63 in 2009 to $3.21 in 2011
- Cash flow per share increased from $4.37 in 2009 to $6.48 in 2011
- A projected growth rate of 22.5% for 2012 according to dailyfinance.com
- Zack's has Projected EPS of $3.33 for 2013 which represents an increase of $0.63 over its projected EPS for 2012 of $2.70
- $100K invested 10 years ago would have grown to $225K.
Charts and tables of interest
The stock has had a nice run up and now faces resistance in the $30-$31 ranges. If it fails to break through this zone shortly, it should lead to a test of the $27.50-$28.00 ranges before trending higher. There is a slight chance that it could trade down to the $24.00 ranges. A weekly close below $27 would be a pretty good signal that it could trade down to the $24 ranges. A weekly close above $32.00 should be enough to propel it to new highs. We would wait for a pullback to the $27.50-$28.00 ranges before putting this strategy to use. Keep some money aside so that if it drops to the $24 ranges, you could put this strategy to us again.
The April 2013, 28 puts are trading in the $1.82-$1.88 ranges. We would wait for the stock to pull back to the $27.50-$28.00 ranges before selling these puts. If the stock pulls back to the above ranges, these options should trade in the $2.60-$2.80 ranges. We will assume that the puts can be sold at $2.60 or better.
The April 2013, 33 calls are trading in $1.20- $1.24 ranges. If the stock pulls back the stated ranges, these options should trade in the $0.80-$0.90 ranges. We will take the midway point and assume that the calls can be purchased at $0.85. For each put sold, you would be in a position to purchase up to 3 calls.
Benefits and Risk associated with this strategy
You have an opportunity to significantly leverage your position in this stock for a relatively low fee. You would only need to put up $2800 to secure the put, but you would be in a position to control 300 shares.
You also have the opportunity to get into the stock at a lower price. If the stock trades below the strike price, you sold the puts at, the shares could be assigned to your account. Depending on the number of calls you purchased your cost per share could range from $31.95 (if you purchased one call only) to $32.95 (if you purchased three calls). Assignment usually occurs on the last trading day of the option.
As long as you are bullish on the stock and would not mind owning the stock at a lower price, the only real risk is that you have a change of heart, and perhaps you now feel that the stock could trade well below the strike price you sold the puts at. One solution to this is to roll the put. Buy back the old puts and sell new out of the money puts.
Investors should consider closing half the position out if the calls are showing gains in the 60%-100% ranges. If you are not interested in having the shares assigned to your account, then buy back the puts you sold when you decide to close out your call position.
Options tables sourced from yahoofinance.com. EPS consensus estimates and EPS charts and some of the Research and historical data used in this article were obtained from Zacks.com. Competitor comparison data sourced from yahoofinance.com
It is imperative that you do your due diligence and then determine if the above strategy meets with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware