Pumping Out Profits

I have had a lot of success trading deepwater oil driller Transocean (NYSE: RIG) over the past three years. Further below, I will explain my newest RIG trade. But first, a quick summary of how we got here.

In August 2020, I suggested buying a long-term call option, or “LEAP”, on RIG that expired in January 2022. At that time, RIG was trading around $1.30. I recommend buying the $1.00 strike price that was selling for 80 cents.

As I noted then, “For that trade to become profitable, RIG must rise above $1.80 within the next 16 months.” It did a lot better than that. After RIG rose above $5.00 less than one year later, that position could have been closed out for a 400% profit.

In January 2021, while RIG was trading below $3, I observed that RIG might become the target of a short squeeze. I said then, “If Transocean can avoid bankruptcy, it could rebound strongly this year. Short interest in the stock is around 20%. If the short sellers have to buy RIG to cut their losses, it could shoot higher.”

And shoot higher it did. As previously noted, that June RIG was trading above $5. Had you bought the stock in January, you could have booked a 100% profit in just five months.

Until recently, RIG has spent the past year struggling to break above $4. But since the start of this year, RIG has rocketed above $7 despite posting tepid fiscal 2022 Q3 results three months ago (circled area in chart below).

Setting the Stage

That sets the stage for my new RIG trade. But this time, I think the stock is likely to head lower in the near term rather than higher.

Expectations for RIG are running high on Wall Street. Two weeks ago, the company announced that it won a $392 million contract to drill for oil off the coast of Brazil. However, that work is not expected to start until the second half of this year.

That won’t help the company’s 2022 Q4 results, which will be announced after the market close on February 21. In fact, it won’t do much for this year’s results, either. Nevertheless, RIG is trading at its highest share price in nearly four years.

Also not helping Transocean is the price of crude oil, which has fallen by more than a third since peaking above $120 a barrel last summer. For a deep ocean driller like Transocean to be profitable, oil prices must remain high.

There is another factor working against Transocean’s fourth quarter performance. According to the International Energy Agency (IEA), “World oil demand is set to contract by 110 kb/d (thousand barrels/day) in 4Q22.”

Add it all up, and what you have is an overbought stock primed to disappoint Wall Street when it releases its Q4 results on next week. From a technical perspective, RIG is bumping up against its upper Bollinger Band and is severely overbought according to its RSI (relative strength index).

Hit or Miss

Since I believe RIG is likely to decline in value in the near term, I will use a put option for this trade. A put option increases in value when the price of the underlying security goes down.

Last week while RIG was trading near $7.50, the put option that expires on February 24 at that strike price could be bought for 50 cents. For this trade to be profitable, RIG must fall below $7.00 by the end of next week.

If RIG falls to $6.50 by expiration, the gross profit on this trade would be at least 100%. If it drops all the way to $6.00, that would equate to a 200% gain.

Of course, just the opposite could happen. If RIG reports solid Q4 results and/or issues optimistic guidance for this year, then this option could be worth nothing.

That’s the risk you take trading short-term options. The upside is enormous, but so are the potential losses.

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