Most investors are familiar with the basic parameters of stock options. A call option gives the buyer the right to buy a specific stock at a predetermined price within a certain timeframe. A put option gives the buyer the right to sell a specific stock at a set price within a certain timeframe.
When you sell options, however, the responsibility shifts from a right to buy or sell to an obligation to buy or deliver the underlying stock. With equity values of energy companies collapsing over the past several weeks, long-term investors may wish to consider selling puts on them.
When you sell a put option, you are obligating yourself to buy the underlying stock (in option parlance, this is known as having the stock "put" on you) at a certain price inside a certain timeframe. For this obligation you are paid an option premium.
With shares close to $10, Chesapeake Energy (CHK) may be one of the most compelling energy bets today. The company is refreshed with a fantastic CEO in Doug Lawler who is monetizing assets very attractively. Chesapeake's book value today stands at $15 and what is intriguing is that this value reflects an asset write-down to reflect today's lower energy prices.
Because of this and many other facts that I've written about over the past months, I recently sold a boatload of the January 2016 $10 put contracts for around $1.25 or $125 per contract. If Chesapeake shares fall to $10 any time between now and the third week of January, I will be required to buy the equivalent amount of shares based on the contracts I've sold. But I keep the premium, essentially paying $8.75 per share of CHK stock -- a price I'm willing to load up on. If, on the other hand, shares don't touch $10, I keep the option premiums.
The caveat to selling puts, in my view, is to be willing and able to own the stock. If you sold 100 contracts of CHK based on the above and had to take delivery of the shares you will have to be able to buy 10,000 for $10, or $100,000 less the premium you are paid. Selling put options creates a lot of leverage that you have to be able to assume.
But if you believe that energy stocks are in a cyclical downturn and that the cycle will reverse itself over the next several years, now may be a good time to put long-term capital to work. In addition to Chesapeake, Murphy Oil (MUR), Consol Energy (CNX) and BP (BP) are attractive names to consider. These are all names that can withstand the low price environment and do well if oil stabilizes near today's prices.
The bottom for oil may not have been reached yet, and prices that look low could get lower. Before selling any puts, the idea of owning the stock has to be attractive to you.
