Take Advantage Of Chesapeake's Woes With Covered Calls

| About: Chesapeake Energy (CHK)

Chesapeake Energy Corp. (NYSE:CHK) was once an industry darling, having propelled its self to the position of the number two natural gas producer in the country. However, over the past year, the company's finances have been in turmoil for several reasons.

Second to Exxon Mobil (NYSE:XOM), Chesapeake's stock has been all over the place in recent weeks in terms of trading as investors try to digest a slew of bad news about the company. The jury is out on how much the company will be impacted, but in the short term, investors may consider options trading as a way to capitalize on the turmoil.

Chesapeake has been hammered by investors because of its financial woes, and is referred to as the worst performing stock in the oil and gas sector over the past year. At the time of writing, the stock was trading around $14.60. This was flirting with its 52-week low of $14.49, which is way off from the company's 52-week high of $35.75.

Chesapeake's problems partly stem from declining natural gas prices. In fact, natural gas prices are at record low levels that haven't been seen for more than a decade. Industry players sum up the situation this way: natural gas prices have fallen so low that drilling for it is no longer profitable.

For Chesapeake, that is spelling disaster. Since being founded in 1989, the company has been busy buying up land to expand its drilling for natural gas, especially in the U.S. In fact, it touts its self as being the most active driller of new wells in the U.S.

Now it is scrambling to cover a $4 billion revolving credit facility that was taken out to help it with its drilling needs. Chesapeake is planning to repay the loan with the proceeds from assets that it is planning to sale this year. Those sales total $9 billion to $11.5 billion, according to the company.

In the works is a $3 billion loan from Jefferies & Co. (JEF) and Goldman Sachs (NYSE:GS). Plans are to repay this loan by the end of the year.

Aggravating the situation is the possible mismanagement of funds by the company's chief executive officer Aubrey McClendon. At issue is whether or not McClendon mortgaged his personal stakes in the company's oil and gas wells to companies that had lent money to the company, according to Reuters.

While the issue with McClendon is troubling, investors are rightfully more closely examining how the company will unload major assets to deal with its cash flow problems. The situation has grown so worrisome that some investors are demanding his removal. On Monday, London-based Noster Capital sent an open letter to Chesapeake's board asking that McClendon be removed, according to Reuters.

In the meantime, I expect the company's stock to continue its roller coaster ride as far as trading is concerned. Just this week, Chesapeake's shares fell more than 5% after investors were unimpressed with the latest news from the company about its cash flow situation.

I also believe that things for the company will worsen before they get better. Its cash flow problems are acute, and must be addressed immediately. The company seems to not have a clear plan, and that is also troubling. For example, on Monday it canceled plans to raise money through a payment from one of its wells in Texas.

For investors that play their cards right with options trading, Chesapeake's woes could pay off.

If you think that Chesapeake's stock will decline like I do, you may consider buying a put option or a covered call. The benefit: if Chesapeake declines and you have a covered call, you will lose less than if you just owned the stock outright. Keep in mind that covered call risks are lower than buy and hold risks. If you set the strike price low enough, it is altogether feasible that you will be able to make money on Chesapeake if the turmoil continues and negatively impacts its stock price.

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

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