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Buying Kodiak Oil & Gas And Selling A Covered Call

|Includes: Kodiak Oil & Gas Corp (KOG)

09/03/13 Covered Call Pick: Kodiak Oil & Gas (NYSE:KOG)

Kodiak Oil & Gas (KOG) is an oil and natural gas company engaged in the exploration, development, and production of oil and natural gas sites and products. Located in the Rock Mountains' Williston and Green River Basins, Kodiak Oil and Gas has over 95,000 net acres, with over 21 oil-producing wells across Montana and North Dakota, including the prosperous Bakken region.

Kodiak Oil & Gas has a market capitalization of $2.6 billion, with 265.6 million outstanding shares.

Kodiak Oil & Gas currently pays no dividend.

With a beta of 1.46, KOG trades with approximately 46% greater volatility than the current market.

KOG is another stock that seems to break the mold of what we normally pitch as a great Covered Call pick. The company has a low market capitalization, doesn't pay a dividend, and is rather volatile. While the stock is missing all of those normally highly desired characteristics, what it lacks in those aspects, it makes up for in growth.

The stock has a Return on Equity of 14% which is, admittedly, not extremely impressive. What is impressive is the massive EPS Growth Rate calculated over the past 3-5 year period, coming in at 237%. This year's EPS is estimated to come in 40% than last year's, and 2014's estimates are 52% over this year's. Despite the massive growth, the valuation has stayed relatively low at 20 compared to the stock's 5-year P/E high of 193. Looking beyond the standard metrics for growth, we see KOG making acquisitions and developing new sites in one of the most profitable and fastest growing oil and natural gas sites in the United States: the Bakken. Just this past July, KOG acquired additional properties of about 42,000 net acres in the Bakken and Three Forks regions from Liberty Resources for $660 million. These properties are estimated to net 5,600 barrels of oil equivalent per day, a nice addition to the quickly growing company.

KOG is growing so well that it is Ranked #2 in MarketSmith's Top 150 Fastest Growing Stocks list, and is in IBD's Top 150 which lists the top 150 fastest growing stocks according to Investor's Business Daily.

All of this wonderful growth and the positive growth outlooks for the company and the stock have caught the wind of the big guys. The Accumulation/Distribution Rating according to MarketSmith, which tracks how many 10,000 share lots are being bought and sold indicating institutional investment, comes in at A-. This shows that mutual and hedge funds are finding opportunities in the stock. This has led to an Up/Down ratio of 1.46 showing belief in the story behind KOG.

Technically, the stock is in a buy range. It has just broken out of a nearly 12-month consolidation range, and has the ability to shoot higher on momentum. We could easily see the stock rocket upwards quite a bit, but because we are looking for a Covered Call Strategy on the stock, we want to get reasonably paid for holding the stock as KOG pays no income on its own. The Call will end up limiting our upside potential, but will create a "surrogate dividend" to provide us with some income, and a bit of downside protection since the stock is slightly volatile. We are also recommending buying 500 shares of the stock and selling 5 Calls on those shares, as the price of the stock is quite low. That is why we are recommending buying KOG and selling the December 2013 $11 Call.

Scenario:
 

  • Buy 500 shares of KOG @ $10.10 = $5,050 + Commission ($12.95) = $5,062.95
  • Write 5 KOG December 2013 $11 Call @ $0.35 - Commission ($8.70) = $166.30

Note: Prices may vary from the time of post. Actual commissions paid will vary returns.


Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration

(0.33)/10.13 X (365)/103

= 11.54% Static Return


If-Called Return:
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

(0.33 + 11 - 10.13)/10.13 X (365)/103

=41.98% If-Called Return


Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.

Posted by OaktreeAdvisors at 9/3/2013 9:53 AM
Categories: Weekly Picks

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Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in KOG over the next 72 hours.