John Mylant's  Instablog

Last time I wrote an article on Chevron (CVX), I perceived a trading zone for the stock. It the beginning of May and I thought the stock would trade (99-108) for a period of time. Well, now it is June and I shall revise my ideas of where the stock may be going short term. It has plenty of room to retreat more and the present market conditions may help it do just that.

There are a number of events that will dip into the possible revenue streams of the company as well as legal issues. There are many on going legal issues the company has to budget for.

Ecuador

Maybe not its own fault, but when it bought Texico it also inherited the problems of the company. Just last year, an Ecuadorean judge ordered the company to pay as much as $18 billion in recompense and penal damages for Texaco Inc.'s alleged dumping of toxic drilling wastes in the Ecuadorean jungle from 1964 to about 1992. Chevron states Texaco cleaned up what it did and is pointing fingers at PetroEcuador which took over the fields after Texico. It claims there was an agreement between Chevron, Texico, and PetroEcuador that it would be released from any future liabilities. Chevron acquired Texaco in 2001. Now plaintiffs are going after asserts worldwide. Recently lawyers representing residents of an Amazon rain forest filed a lawsuit in Canada to seize assets there belonging to Chevron Corp. as part of their effort to collect an $18.2 billion judgment they won in Ecuador in a pollution case.

Brazil

A Brazilian federal judge denied a request from a prosecutor seeking to ban Chevron Corp and Transocean Ltd from operating in the country. The reason behind the action-two oil spills. There is a $11 billion lawsuit addressing environmental damages that ignited after the most recent oil spill just this spring at its Frade field. Brazil is increasing surveillance of offshore oil production as it attempts to avoid a Brazilian version of the 2010 Macondo spill in the U.S. Gulf of Mexico. Chevron is also battling a separate lawsuit by the country's main oil union to ban it and Transocean from operating in the country.

Between the two, Chevron's legal war chest is digging into profits. Now, if that is not bad enough, the demand for its product-oil is drying up this summer. The price of oil continues to decline as supplies grow in the U.S. It dipped to a seven-month low of $91.81 earlier and is down about 12 percent overall since the beginning of May. Prices fell after the government reported that U.S. oil supplies grew last week by 2.1 million barrels. Storage levels are now the highest in nearly 22 years. Prices tend to decline when more oil is available.

If we look at the stock on a weekly chart, the recent break through the wedge pattern on the bottom leads me to believe-along with the other events taking place in the world, (This includes Chevron's legal actions and the lower demand for oil) I believe the stock has lower to go. I have identified three possibly support levels it still may fall to before its eventual rise. For this reason I would initiate a short term income strategy while it is still falling. Let's look at a Bear Put Spread. Chevron is trading at 96.41 at the writing of this article.

(click to enlarge)

The Options Play

• Buy a September 2012 put with a strike of '95.00' (priced at $5.50)
• Sell a September 2012 put with a strike of '92.50' (priced at $4.45)
• Net Debit to Start: $1.05
• Maximum Profit: $1.45

Reasoning behind the Trade

• Markets are very bearish.
• Oil is well stocked presently so production will slow down meaning less revenue and falling oil prices short term.
• Law suites will dip into costs.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.