Getting a Bigger Lift Out of Chevron

One year ago, I asked, “Is it Time to Pocket Profits on Energy Stocks?” I noted that the iShares U.S. Energy ETF (IYE) had nearly tripled in price over the previous two years. Surely some reversion to the mean was in order, especially if the war in Ukraine ended sooner than feared sending oil and natural gas prices lower.

Of course, the war in Ukraine still rages on as do the economic sanctions imposed on Russia oil and natural gas production. Nevertheless, the price of oil has fallen from $130 a barrel thirteen months ago to less than half that price last month.

As a result, most energy stocks have stagnated. During the past year, IYE has bounced around but gained no new ground. That’s bad news if you are a shareholder of IYE.

However, that’s good news for the options trade I recommended a year ago. In that article, I suggested selling a covered call option on Chevron (NYSE: CVX) at the $185 strike price that expired in November. A call option increases in value when the price of the underlying security goes up.

At that time, that option could be sold for $10. As I explained, “That means CVX would have to rise above $195 within the next seven months for this trade to be inferior to simply holding onto your shares.”

I further observed, “I don’t know how likely that is, but I’d be surprised if CVX appreciated another 11%+ this year given its recent surge.” It did not. The closest it came was the week before that option expired, when CVX peaked a little below $190.”

Had your shares been called away from you that week at the $185 strike price, you could have bought them back four months later for less than $160.

The Right Trade at the Right Time

Either way, that was the right trade at the right time. The best time to sell a covered call option is when the underlying security is peaking after a long run up the charts. That is when optimism and call option premiums are at their peak.

That is no longer the case for the energy sector. Today, that same trade would fetch roughly half the option premium from a year ago. Wall Street is pessimistic that the big oil companies can repeat last year’s record profits.

For that reason, I think now is a good time to sell a put option on Chevron. A put option increase in value when the price of the underlying security goes down. Similar to IYE, CVX has also vacillated back and forth during the past year but gone nowhere.

Last week while CVX was trading near $170, the put option that expires on September 15 at the $160 strike price could be sold for $7. Effectively, this is the inverse of last year’s trade.

If CVS falls below $160 within the next five months, there is a chance you would have to buy it at that price. But remember, you were paid $7 to take that risk so your adjusted cost basis could be only $153.

I would be happy to pay that price for Chevron. That is 10% below where CVX is currently trading. At a forward P/E (price-to-earnings) ratio of 11, CVX is trading at a sizable discount to the S&P 500 Index.

Also, its forward annual dividend yield of 3.5% is roughly equivalent to the yield on the 10-year Treasury Note. At a 10% discount, that works out to a dividend yield of closer to 4%.

Rearview Mirror Investing

As it often does, Wall Street is engaging in rearview mirror investing. By the time it figures out that most of the risk in the energy sector has already been realized, CVX will be back up above $180.

That may not happen until the second half of this year. The economy is weak, and the Fed isn’t sure if it should keep raising rates to combat inflation or start cutting them to avoid a deep recession.

My guess is the stock market won’t be able to muster a sustained rally until after Labor Day. By then, the put option trade I just described will be on the verge of expiring.

For that reason, I believe this same strategy can be used for many stocks that are stuck in a trading range until the economy get going again. That won’t thrill buy and hold index investors but it is great news for options traders that know how to use it to their advantage.

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