The benchmark price for oil is down from over 110 per barrel to under 47 after today’s 4.5% decline. Time for all raptors to begin salivating!
Your head raptor was an accounting and budget monkey in the oilpatch before he turned to trading full time. I can’t tell you what the price of oil of any other commodity will be in the future with certainty. But I can make an educated guess. What isn’t likely to change (much) is that global oil consumption is a little over 90 million barrels per day (93 if you like to split hairs) and can be expected to stay around that level in the months and years ahead. There is currently an oversupply driving the price to crash. The Saudis are also trying to play chicken with American producers but it is a game they will (mostly) lose.
The Saudis and other OPEC nations don’t have 90+ million barrels per day to give. North America with its oil sands and shale oil have to step in to cover the shortfall. For sure, the marginal North American producers will get shaken out. If you hold any oil companies in your portfolio that have high lifting costs and a heavy debt load, you should be looking for a sucker to unload them on! But the big integrated international oil and gas firms are built to withstand the price shock. The big boys can all make money in the high 30s to low 40s and based on demand, the rate of production decline in existing shale wells, and the reduction in exploration and production capital spending; I expect the intermediate to long term price for WTI crude to settle into a range betwee 45 and 60 a barrel. But count on lots of volatility and a trip to 30 first.
The very tasty morsels that are ripe for trading are Chevron (CVX), Royal Dutch Shell (RDS-B), and British Petroleum (BP). I am going to show you how to make the most of these increasingly attractively priced slabs of raptor satisfying meat.
One of the Financial Velociraptor’s favorite strategies is the “buy-write” strategy. This is a strategy that starts with a solid company, preferrably with a solid dividend yield and long history of shareholder friendliness like today’s selections, and ends with earning some bonus yield in the secondary markets.
Start by buying 100 share lots of your target company. Once the shares are in your account, you will “write” (sell) near the money call options on the underlying shares. Somewhere out there, there is always a prey animal that is driven by greed and the lure of leverage who will pay you handsomely for the right to buy your shares in the future for a price greater than what they are selling for now. I’ll outline the three options below:
Royal Dutch Shell closed today at 64.48. Let’s use that as our reference price as it is the best estimate of what we can expect to pay first thing in the morning. Checking the options listings at Yahoo Finance we find that the 20FEB2015 65 strike calls (RDSB150220C000650000) are selling for about $1.94. Excellent! This means we can put 6,448 of capital at risk and collect $194 in cold hard cash in only 35 days for accepting that we might have to give up our shares for 52 cents more than we paid.
Chevron closed today at 102.67. Yahoo reveals we can sell a similar contract as above on the 20FEB2015 expiry at the 105 strike (CVX150220C00105000) for 2.67. Delicious! For each 10,267 we put at risk, we can collect 267 dollars in cash in only 35 days. And the “downside” is we might take 2.33 cents per share in capital gains sooner than anticipated.
BP closed today at 35.73. Our reference reveals the 20FEB2015 expiry 36 strike calls (BP150220C00036000) are going for 1.17. Again, in only 35 days, we can collect cash of 117 dollars while putting only 3,573 of capital at risk. And we will be glad if we are “wrong” and are compelled to sell at 36 dollars in 5 weeks.
Let’s look at the percentage returns:
If the companies we bought close below the strike price on our options (they might rise too little, trade sideways, or decline), we keep our shares and write new calls to collect income again! We also remain eligible for dividends. The returns might then look like – RDS-B 3.01% over 35 days or 31.38% annualized. We also retain a chance to collect the tasty 5.3% dividend yield. – CVX 2.60% over 35 days or 27.12% annualized. Dividends could be as much as another 4.00% annually. – BP 3.27% over 35 days or 34.15% annualized. The current yield on BP is also 6.60%.
What happens if oil recovers sooner than expected and our shares rise above the strike and are called away? Simply, we sell the shares at the previously agreed to price and keep every penny of the income we collected on the contracts. Those gains look like this – RDS-B 3.82% / 39.79% annualized, CVX 4.89% / 50.79 annualized, BP 4.03% / 42.03% annualized.
A raptor can get mighty fat on 30 to 50% annualized returns and it isn’t necessary to put capital to risk in momentum stocks with sky high multiples of earnings and cash flow. Good old fashioned blue chips have plenty of meat on the bone!
Devour your prey raptors!