Energy Stocks Could Lead Rally and This Stock Could Provide a 26% Gain
Trade summary: A bull call spread in Cheniere Energy, Inc. (NYSE: LNG) using the March 20 $52.50 call option which can be bought for about $1.98 and the March 20 $54 call could be sold for about $0.79. This trade would cost $1.19 to open, or $119 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $119. The maximum gain is $31 per contract. That is a potential gain of about 26% based on the amount risked in the trade.
LNG reversed on news that business in China might be as badly affected as traders seemed to be fearing.
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The strong reversal, leaving what could be a spike low on the daily chart, could be bullish. A short term rally towards resistance levels of $56 top $60 could slow a rally, but those targets provide significant up side potential for leveraged traders. Leverage can be obtained using options and can boost gains.
The stock rallied after Reuters reported, “Energy infrastructure company Sempra Energy said on Thursday the spread of coronavirus had not impacted talks with buyers of liquefied natural gas (LNG), easing some worries after the virus outbreak cut gas demand in China earlier this month.
Short-term sales of LNG into China, the world’s second largest importer of the fuel, almost ground to a halt earlier in February as the outbreak slowed economic activity and hurt demand, and buyers pondered legal action to avoid having to honor purchase agreements.
However, more recently, China appeared to be slowly recovering its appetite for natural gas, with LNG imports rising last week for the first time in five.
“In terms of conversations with counterparties … we have a long-term view about supply and demand in the middle part of the decade and we’re really dealing with people … that have a shared view of a potential infrastructure shortage,” Sempra Chief Executive Officer Jeffrey Martin said.
“The virus issue hasn’t really impacted our negotiations with the customers we’re talking to.”
Cheniere Energy Inc, the biggest U.S. LNG company, said earlier this week it was too early to gauge the potential impact of the outbreak on the near-term LNG market, but the lower short-term LNG demand in China was putting additional pressure on the market.
Even before the virus spread, global gas prices had been falling for months on mild winter weather in Europe and Asia, record stockpiles in Europe and slow economic growth because of the U.S.-China trade war.
Sempra, which develops, builds and invests in natural gas liquefaction facilities, said it expects to make final investment decisions this year to build two new LNG export plants, one in the United States and one in Mexico. “
The stock fell to important support near $45. This was where a significant rally began in 2018 and could be the launching pad for the next rally in the stock.
Now, let’s look at the details.
A Specific Trade for LNG
For LNG, the March 20 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A March 20 $52.50 call option can be bought for about $1.98 and the March 20 $54 call could be sold for about $0.79. This trade would cost $1.19 to open, or $119 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $119.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in LNG the maximum gain is $31 ($54- $52.50= $1.50; $1.50 – $1.19 = $31). This represents $31 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $119 to open this trade.
That is a potential gain of about 26% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying LNG could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.