Oil Is Off Its Peak - Time to Buy Oil Stocks Like ConocoPhillips?

Oil is off its peak prices, and it could be a good buying point for oil stocks like ConocoPhillips (COP). One way to do this is to set a lower buy-in point by shorting out-of-the-money (OTM) puts.

COP closed at $122.55, off its recent peak of $133.80 on March 27, during the height of the Iran war.

I discussed this in a Barchart article at the time on March 24, “Is ConocoPhillips Stock at a Peak? - Covered Call COP Plays Look Attractive.”

At the time, analysts had an average price target of $123.67. But now, Yahoo! Finance's average analyst price target is $134.63.

As a result, it might make sense to set a lower buy-in point, as a margin of safety. One way to do this is to sell short out-of-the-money (OTM) puts in one-month expiration periods.

Shorting OTM COP Puts

For example, look at the May 15 expiry period. It shows that the $110.00 strike price, which is over 10% below Friday's close, still has an attractively high premium.

The midpoint price is $1.22. That means that an investor who secures $11,000 in collateral with their brokerage firm can enter an order to “Sell to Open” this contract. Here's what happens:

  $122/$11,000 = 0.01109 = 1.109% for one month

Downside Issues

Moreover, the delta ratio is very low, -0.16. That implies there's just a 16% chance, based on COP's historical volatility, that the stock will drop to $110.00 in the next 34 days.

Therefore, less risk-averse investors might be willing to sell short the $115.00 strike price put option contract. That allows them to receive $228 after posting $11,500 as collateral:

  $228/$11,500 = 0.01983 = 1.983%

This strike price is still over 6% below COP's April 10 close. But the yield is much higher, almost 2.0% over the next month.

Note that the delta ratio is -0.2673. This implies only a 27% probability that COP will drop by 6%. That could potentially leave an investor with an unrealized loss. That happens if COP stays below $115.00 and the account is assigned to buy shares at $115.00.

However, even if this happens, the investor's breakeven point is much lower:

  $115.00 - $2.28 = $112.72 breakeven

That's almost $10 lower than Friday's close, i.e., 8% lower.

Repeating The Play for a Compounded Return

The point is that this is an attractive way for value investors to set a lower buy-in and get paid while waiting.

For example, if an investor can repeat this play every month for 3 months, the potential total return is almost 6%:  1.983% x 3 = +5.949%.

That is the same as buying COP today and seeing it rise to $129.84:

  1.05949 x $122.55 = $129.84

That's close to its recent peak price. So, if the put option premiums remain elevated over the next 3 months, this is a better way to play COP than just buying shares.

And don't forget this: even if the account is assigned to buy shares at the shorted strike price, an investor can do a covered call play. 

That way, the account can make income that can reduce any potential unrealized loss.

The bottom line is that COP could be cheap here, and one way to play it is to short out-of-the-money (OTM) puts.