Oil & gas giant Occidental Petroleum (OXY) looks like a great options trade right now.
And, apparently, I'm in good company with this idea.
Real Money's Doug Kass mentioned in his Daily Diary that Occidental has grown to be a Top 5 position within his portfolio. In addition, Warren Buffett's Berskhire Hathaway (BRK.B) has been buying this name hand over fist for months. Those are some solid investing stalwarts to join in this trade.
Occidental does not have a 3%-plus dividend yield like industry giants Exxon Mobil (XOM) or Chevron (CVX) . That is OK, though. We can create our own synthetic income stream by using a simple covered call strategy. Options, as one would expect, are very liquid against this equity. Occidental has significantly underperformed its peers over the past half-decade thanks to some missteps. However, earnings have gone from just over $4 billion in fiscal 2018 to north of $13 billion in fiscal 2022.
As free cash flow has grown from just under $2.7 billion to over $13.5 billion in that same time frame. The company has seen improving operational efficiency and is a much more prudent allocator of capital than it has been in the past. Berkshire has been a big supporter of management and with its latest purchases in late March, has taken its equity stake up to nearly 24% of the company. In addition, Berkshire owns $10 billion of Occidental's preferred stock with an 8% dividend, as well as warrants to buy another $5 billion of common stock at $59.62 each. Occidental's total market capitalization is just over $55 billion
Berkshire's large stake in the company and its purchases in the shares on dips should put a nice floor under the stock to understate the situation. In addition, Occidental announced a new stock buyback authorization of $3 billion at the end of February. The company also boosted its quarterly dividend by nearly 40% at that time as well, although the stock still yields only just over 1.1%
The stock is cheap on a trailing cash flow basis, but deleveraging by redeeming the preferred shares could continue to act as an overhang on stock appreciation for a while. One reason the stock has been mostly rangebound throughout 2023 to this point. However, that sort of sideways action lends well to a covered call strategy such as the one outlined below.
Option Strategy:
To establish an initial position in OXY using a covered call strategy, we are going to pick an option strike price just below the current trading level of the stock. Selecting the January $60 call strikes, fashion a covered call order with a net debit in the $52.40 to $52.50 a share range (net stock price - option premium). This strategy provides downside protection of approximately 15% including dividend payouts as well as similar upside potential even if the stock does nothing over the option duration.
