Flash Alert: ExxonMobil Covered Call and Buying the Dips

In the Dec. 24, 2008, issue of The Energy Strategist, Buy Income, Super Oils and Gas, I recommended a covered call position in ExxonMobil (NYSE: XOM). I updated that recommendation in S&P 500 Contagion, a Flash Alert issued on February 24, 2009.  Investors unfamiliar with covered calls should examine my detailed explanation in the issue from Dec. 24, 2008.

Late in 2008 and early in 2009 was a perfect time to employ the covered call strategy. Due to extreme volatility in global credit, stock and bond markets, options on stocks became extremely expensive relative to historical norms. Because the covered call strategy involves selling call options to earn premium income, expensive options are a big advantage.

We took advantage of these unusual conditions by recommending covered calls on ExxonMobil and Hess (NYSE: HES). The latter trade was closed for a profit of 34.4 percent on May 18.

As of October 16 the call options I recommended selling against our position in ExxonMobil expired and are worthless because the stock closed below the $80 strike price of the calls. As I explained in Buy Income, Super Oils and Gas, this is excellent news because it means that you get to keep the entire premium from the calls sold and still own shares in Exxon.

But the market is a lot less volatile than it was back in February, and call options are cheap; we’ll no longer earn much of a premium by selling new calls against our Exxon position.

This leaves us with two options: holding onto Exxon without selling more calls, or selling the stock for a total gain of about 10 percent. I’m opting for the latter.

Exxon is the world’s largest publicly traded company and benefits from an extremely low cost of production and a bulletproof balance sheet. However, Exxon has limited opportunities to grow its production in coming years. The company just doesn’t have enough new exploration and development projects to move the needle. As a result, the stock tends to lag in strong energy markets because it doesn’t have much upside leverage to crude or natural gas prices.

I don’t think investors will be badly burned by owning Exxon. However, I see far more upside in my other TES recommendations; if we can’t earn a decent return by selling calls against the stock, there’s no point in holding onto Exxon and tying up the capital.

I recommend selling ExxonMobil and taking the small profit. Investors should consider placing the proceeds in my other integrated oil and independent producer recommendations: Eni (NYSE: E), Chevron (NYSE: CVX), Anadarko (NYSE: APC) and Petrobras (NYSE: PBR A).

Earnings reports continue to stream in from a number of TES recommendations and the fast pace will continue for another two weeks. As always, I am delving into these reports and conference calls as they’re released and will offer detailed coverage in next week’s issue of TES.

Generally speaking, however, it’s important to highlight the trading phenomenon of “Buy the Rumor, Sell the News” that I have been seeing in some of our recommendations lately.

For example, Wildcatters Portfolio denizen Schlumberger (NYSE: SLB) ran up from $56 in early October to over $70 just ahead of its earnings release, a rally of around 27 percent in about two weeks. The stock rallied because investors were anticipating a strong earnings release from Schlumberger and many thought analysts’ estimates were too low for the stock.

As it turned out, that was the correct view; Schlumberger beat consensus earnings estimates by around 2 cents per share and slightly beat revenue estimates as well. The stock traded higher in the pre-market after its release on a knee-jerk reaction to the results but finished the session lower. The stock has since pulled back to around $64 per share, around 10 percent from its highs.

This is classic trading action: Traders buy in anticipation (the rumor) of better-than-expected results and then take profits when the news actually comes out. It’s totally unrealistic to expect a stock that runs up over 27 percent in two weeks won’t suffer a 5 to 10 percent correction.

Meanwhile, financial journalists spent their time doing their job–that is, explaining a stock’s move after the fact. While Schlumberger was trading higher, the headlines read that it was trading higher based on strong results and guidance. When the stock ended the day lower the headlines read exactly the opposite.

The truth: Schlumberger’s management was characteristically cautious on North American gas services and prices. Schlumberger has less exposure to this market than its peers and as I noted in last week’s issue, it was no great surprise North America was a weak spot. Schlumberger’s comments were consistent with what the other services companies have been projecting–a gradual stabilization in the market, followed by a more pronounced upturn in the second half of 2010.

During the question and answer session management noted that some of the more complex and productive shale plays–Haynesville and Marcellus–were an exception and could experience a recovery in activity and pricing much sooner. This is an important bullish comment for the big services companies because these are some of the most service-intensive plays in the US.

Some also seized on Schlumberger’s comments about international companies being reluctant to increase spending until they’re sure oil prices have stabilized above $70 to $75 a barrel. What’s particularly amusing about this is that it’s almost the exact same comment, with the same wording, that CEO Andrew Gould made in the second quarter conference call.

I’ll have more to say about Schlumberger in next week’s issue. But the bottom line is that the hullaballoo about negative commentary in energy conference calls is rubbish; the stocks are simply seeing some profit-taking after big run-ups in recent weeks. I recommend using any dips in TES recommendations as an opportunity to buy. The last three issues of the newsletter provide a rundown of my favorite plays.

There’s one exception: Wildcatter Portfolio holding Weatherford International (NYSE: WFT). This stock has underperformed Schlumberger and the other services names in recent weeks due to concerns that the Mexican national oil company (NOC), PEMEX, will seek to renegotiate contracts on its Chicontepec play. I explained this scenario at some length in the last issue of TES, Off to a Good Start. But some comments in the Mexican press and out of the Schlumberger call have further stoked these fears.

The current thinking is that PEMEX may look to link some of the pay companies receive from this play to performance. Because Weatherford has the most contracts compared to its size from Chicontepec, the stock has been more impacted than the other services names.

But the key point to remember is that Mexican oil production is plummeting, falling around 10 percent in 2008 and a further 6 percent in the first 9 months of 2009. Chicontepec will need to be developed to halt this decline, and that’s impossible unless the services companies are willing to participate. Pemex will likely come up with some deal that continues to reward the services companies but provides the government with the political cover that it’s not overpaying to develop the field.

Traders have overreacted massively, and Weatherford looks like a particularly good value at current levels.

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