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On the 6th of July, we wrote an article advising traders to sell puts and to use the proceeds from the sale of the puts to purchase calls on Kodiak Oil and Gas (KOG). This strategy provided individuals who were bullish on the stock with the opportunity to significantly leverage their position in this company for a relatively low fee. Secondly, it also provided investors who were bullish on the stock with the chance of getting in at a much lower price. If the stock traded below the strike price the puts were sold at, the shares could be assigned to your account. This trade proved to be a winner as the call options soared in value, and the puts have lost roughly 60% of their value.

In this trade, we suggested selling the Jan 2013, 7.50 puts for $1.00 or better. This was easily achievable as the option traded well above $1.10 on the same day and for several days after that. Our exact comments from the article were as follows:

It appears to have put in a bottom, and as long as it does not trade below 6.50 on a weekly basis the outlook should remain bullish. The Jan 2013 7.50 puts are trading in the $0.95- $1.10 ranges. Sell these puts for $1.00 or better. As the stock is rather volatile, it should not be a problem to sell this put at this price. For each contract sold $100 will be deposited into your account.

The proceeds from the sale of the puts were used to purchase the Sept 2012, 10 calls. Investors could have purchased as many as 10 calls at the stated price of $0.45 cents. The calls did trade down $0.40 on that day an on several other occasions after that. We advised traders to close this trade out when the calls were showing gains in the 75%-100% ranges

Twelve days later the stock surged to $9.58 (illustrated by green circle in the chart above) and that point the call was only 42 cents out of the money. This move up from $8.40-$9.58 significantly increased the value of the options, and the options were most likely showing gains of 70%-80% from the suggested entry price. Given that the options shot up in value in such a short period of time, traders should have been happy to bank those profits immediately. As the stock never traded below the strike price the Jan 2013, 7.50 puts have lost a significant amount of value since they were sold.

The puts are currently in the $0.40-$0.50 ranges and based on the last trade, they have lost 60% of their value. At this point, you could continue holding onto to them or buy them back. However, keep in mind that $7.50 would represent a pretty good long term entry point for this stock. It still has the potential to trade significantly higher in the near future. A weekly close above $9.80 would be a bullish development, and it should enable the stock to put in a series of new 52-week highs

For those looking to put this strategy into play going forward there are still many reasons to be bullish on Kodiak Oil and Gas:

  • Sales surged from $11 million in 2009 to $120 million in 2011.
  • A strong five-year sales growth rate of 94%.
  • Net income has surged from -$3 million to $3.87 million in the past three years.
  • It has a strong estimated 3-5 year EPS growth rate of 50%.
  • A strong quarterly earnings growth rate of 563% according to yahoofinance.com.
  • Annual EPS before NRI increased from -$0.05 in 2007 to $0.17 in 2011.
  • Cash flow per share increased from $0.01 in 2009 to $0.32 in 2011.
  • Net income for the first quarter came in at $1.74 million. In the 2nd quarter it surged to $93.07 million. At this rate, net income for 2012 could potentially hit the $150-$200 million mark. In 2011, net income was $3.8 million.
  • Sales Vs 1 year 1 year ago increased by 287%.
  • A high beta of 2.64 makes it a good candidate for covered writes or puts if you are bullish on the stock.
  • Year over year projected growth rates of 153% and 72% for 2012 and 2013 respectively, according to dailyfinance.com.
  • An estimated 3-5 year EPS growth rate of 50% according to Zack's.
  • A good interest coverage ratio of 5.4.
  • $100K invested 8 years ago would have grown to $235K.

Charts of interest

When the stock is trading above the EPS and EPS consensus estimate line, it tends to perform better as indicated above and vice versa.

The Competition

Kodiak versus Marathon oil (MRO), Gasco Energy Inc. (GSX) and Double Eagle Petroleum Co. (DBLE)

Suggested options for those looking to put this strategy to use again

Part 1

Sell the March 2013, 8 puts if the stock pulls back to the $8.00-$8.50 ranges. The options should move from the $0.80-$08.5 ranges to the $1.25-$1.40 ranges. If it trades in this range, it should be easy to sell the puts at $1.25 or better. For each contract sold, $125 will be deposited in your account.

Part 2

If the stock trades to the above stated ranges, purchase the March 2013, 10 calls. They are currently trading in the $0.85-$1.05 ranges. They should drop to the $0.55-$0.65 ranges if the stock pulls back to the $8.00-$8.50 ranges. You will be able to purchase roughly 2 calls for every put sold. As the stock is still correcting we would wait for the above ranges to be tested before committing money to this play.

Benefits of this strategy

You have a chance to leverage your position in this stock for almost no cost.

If the stock trades below the strike price you sold the puts at you also have the chance to get into this stock at a significantly lower price.

Risk factors

The only risk factor is that you have a change of heart, and you feel that the shares could trade well below the strike price you sold the puts at. If this is the case, then you can roll the put. You simply purchase the put you sold and sell new slightly out of the money puts.

Conclusion

This strategy produced a very handsome profit in just 12 days. We put the trade out on the 6th of July and on the 18th the calls were only $0.42 shy of being in the money. As the stock moved up almost 14% in just 12 days, the options shot up in value, and traders should have managed to bank 70%-80% in gains over that period of time. We advised traders to take profits in the 75%-100% ranges. Whenever a stock moves up rapidly and there is not too much time left on the option, one should bank the profits as soon as possible as time decay will work against you, unless you are the seller of the option.

Based on the last trade, the puts have shed 60% of their value. We would continue to hold these puts as we feel that $7.50 represents a great long term entry price. If the shares are assigned to you, your final cost will be significantly lower as you can apply the gains from the closed call position to further lower your entry price. Investors looking for other ideas might find this article to be of interest. Marathon: Significantly Boost Your Potential Gains For A Low Fee.

EPS charts obtained from zacks.com. Options tables sourced from yahoofinance.com. Competitors data sourced from yahoofinance.com.

Disclaimer

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.

Source: Review: Kodiak Oil Gas Another Winning Play