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News Might Push This Oil Company to a 209% Gain

News Might Push This Oil Company to a 209% Gain

The news from Saudi Arabia is improving but the region is volatile and stocks in the energy sector are likely to be volatile for some time. As Bloomberg reported,

“American shale producers, one of the worst-performing segments on the stock market this year, jumped Monday morning after an attack on a Saudi Arabia oil production facility over the weekend sent crude prices soaring.

Whiting Petroleum Corp. surged as much as 41%, the most on record, while Apache Corp. and Marathon Oil Corp. were among other names to post strong gains.

The bonds of companies including Whiting and California Resources Corp. also climbed after the global crude benchmark clocked the biggest advance in dollar terms since futures started trading in 1988.

crude oil futures

State energy producer Saudi Aramco lost about 5.7 million barrels per day of output on Saturday after 10 unmanned aerial vehicles struck the world’s biggest crude-processing facility in Abqaiq and the kingdom’s second-biggest oil field in Khurais.

While the attack was seen as good news for U.S. producers, refiners dropped since the bulk of American facilities rely on heavy crude supplied by countries including Saudi Arabia. PBF Energy Inc. fell as much as 10%, while Valero Energy Corp. dropped 7.3%.

The spike in oil prices offers relief at a critical time for U.S. shale producers, which have seen investors flee after the sector largely failed to generate shareholder returns while rapidly growing output.

At the end of last week, independent oil drillers had fallen 25% in the preceding 12 months. Some smaller explorers have filed for bankruptcy or been forced into restructuring their debt. A series of issues — reduced flow from wells drilled too close together, low oil and gas prices, and pipeline limits — have forced producers to slow their growth plans.

The companies that gain the most from the uptick in prices will likely be U.S. producers with sizable short interest, including Apache (NYSE: APA), Continental Resources Inc., Devon Energy Corp. and Noble Energy Inc., analysts at Tudor, Pickering, Holt & Co [noted].

APA is shown below.

APA daily chart

 A Trade for Short Term Bulls

As with the ownership of any stock, buying APA 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.

bull call spread

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.

A Specific Trade for APA

Every day, we scan the markets looking for trades with low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

For APA, the October 18 options allow a trader to gain exposure to the stock.

An October 18 $30 call option can be bought for about $1.16 and the October 18 $32.50 call could be sold for about $0.55. This trade would cost $0.61 to open, or $61 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 $61.

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 APA the maximum gain is $1.89 ($32.50 – $30= $2.50; $2.50 – $0.61 = $1.89). This represents $189 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $61 to open this trade.

That is a potential gain of about 209% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.