Jack Walker

Atlas Pipelines: I'm Out of Here

Skip,

This is a thoughtful and well-prepared article. We may well be near the bottom of natural gas prices but the complexity of this company and all of the financial engineering materially increases the risk and certainly increases the time necessary trying to understand the risk.

Jack

Atlas Pipeline: Call Option on Oil

Tim,

APL does indeed seem like an interesting situation with the stock selling at $7.25. With a trailing four quarters distribution rate of $3.82 the ROI, if it can be maintained is 52%. However, the question is how soon and how much will the distribution rate will be cut?

Assuming it is cut 2/3 that would bring it down to .32 quarterly or at an annual rate of $1.28 it would then be running at a 17.7% rate.

We then suggest going one step further and adding an options collar to protect the downside for the long stock position.

For example, if we look at the May options, which would be about right for the seasonal recovery in crude prices, we find the May 5 put is selling at an indicated mid price between the bid and ask of 1.325 and the May 10 call is selling at 1.175.

The collar trade is to buy 100 shares of stock at 7.25
Buy the May 5 put APLQA 1.325
Sell the May 10 call APLEB 1.175

Based upon the mid price the debit cost of the collar is .15. However, the options are thinly traded so it will cost more, as we will have to sell our call for something less and pay something more for the put. As example, if we paid something between .30 and .45 it would be about right.

Now we would be long 100 shares of stock at 7.25. Assuming we paid .45 for the collar and assuming the next distribution was .32 we will have almost covered the cost of the collar on the next distribution expected in early February and will have exceeded its cost on the May distribution before the options expire.

Now that we have protected the downside let’s look at the upside. If you are right and crude oil prices are back toward the $70 level and APL is trading above $10 then our stock will be called away at $10. Using the assumption above our basis in the stock would now be $7.06. That’s $7.25 for the purchase, plus .45 for the collar, less .64 for the two distributions. The ROI on this hedged position with our stock called away would be 41.6%.

If the stock recovers sooner and is called away before we have received our distributions then we will still have a gain, but not quite as much in a shorter period of time.

If by then there was a good defined uptrend we could do another hedged trade at a higher price.

Jack