Oil Prices Could Pressure This Company
Oil has been in a challenging environment. Analysts at CNBC reported, that oil prices plunge as weak industrial earnings in both China and the United States raise concerns about a global slowdown.
They pointed to the fact that profits at Chinese industrial firms contract for a second straight month, while U.S. bellwether Caterpillar issues disappointing earnings and guidance to support that opinion. Slower economic growth reduces the demand for oil even more.
Despite the potential for lower demand, the analysts also noted that drillers added 10 rigs to U.S. oil fields after reducing the rig count in the prior three weeks. New rigs, of course, could increase supply and as economists note, when demand falls as supply rises, prices fall.
This news is affecting the companies in the sector including Transocean Ltd. (NYSE: RIG) which is raising capital as prices are falling. That could be a daunting challenge.
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GlobeNewswire reported that the company recently announced that Transocean Poseidon Limited, a wholly owned indirect subsidiary of Transocean, has priced an offering of U.S. $550 million in aggregate principal amount of senior secured notes due 2027 to eligible purchasers pursuant to Rule 144A/Regulation S.
The Notes will be guaranteed by Transocean Ltd., Transocean Inc. and a wholly owned indirect subsidiary that owns the Deepwater Poseidon, and will be secured by a lien on the Deepwater Poseidon and certain other assets related to the rig.
The Notes will bear interest at the rate of 6.875% per annum and will be callable after February 1, 2022. The offering is expected to close on or about February 1, 2019, subject to customary closing conditions.
Transocean Poseidon expects to receive aggregate net proceeds of approximately $538 million from the offering, after deducting the initial purchasers’ discount and estimated offering costs.
The net proceeds from the Notes will be used to partially finance the construction or acquisition of the Deepwater Poseidon.
This is another piece of news that points to increased supply. The news comes as a short term rally in the stock appears to have stalled.
The long-term chart shows a similar pattern with a rally appearing to fail.
A Trading Strategy to Benefit From Potential Weakness
The prospects of a further short-term gains in RIG seem to be remote. But, significant weakness is also unlikely. Traders should consider using an options strategy known as a bear put spread to benefit from the expected trading range in the stock.
This strategy can be profitable when a trader is looking for a steady or declining stock price during the term of the options. The risks and potential rewards of this strategy are illustrated in the payoff diagram shown below.
Source: The Options Industry Council
A bear put spread consists of buying one put and selling another put at a lower exercise price to offset part of the initial cost of the trade. This trading strategy generally profits if the stock price moves lower. The potential profit is limited, but so is the risk should the stock unexpectedly rally.
The Trade Specifics for RIG
Every day, we scan the markets looking for trades that carry 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.
The bearish outlook for RIG, at least for the purposes of this trade, is a short-term opinion. To benefit from this outlook, traders can buy put options.
A put option gives the trader the right, but not the obligation, to sell shares at a specified price until the option expire. While buying a put is possible, it can also be expensive. The risk of loss when buying an option is equal to 100% of the amount paid for the option.
To limit the risks, a second put can be sold. This will generate income that can offset the purchase price, potentially allowing a trader to buy a put with a higher exercise price. That increases the probability of success for the trade.
Specifically, the March 15 $10 put can be bought for about $1.70 and the March 15 $8 put can be sold for about $0.45. This trade will cost about $1.25 to enter, or $125 since each contract covers 100 shares, ignoring the cost of commissions which should be small when using a deep discount broker.
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 $125. This loss would be experienced if RIG is above $10 when the options expire. In that case, both options would expire worthless.