This Energy Stock Could Provide a Gain of More than 40%
The beginning of the year always seems to prompt a look back at the previous year. Bloomberg recently did this for energy stocks and our research then identified a trading opportunity in this stock. As the news service reported, “Hess Corp. (NYSE: HES) rose above the carnage in shale stocks with a more traditional approach to oil exploration — partnering in a massive offshore discovery in a frontier nation.
Investors flocked to Hess in 2019 to participate in Exxon Mobil Corp.’s gigantic Guyana oil find, and avoid cash-burning shale specialists.
Hess, which holds a 30% stake in the Guyanese discovery that’s turned into the world’s biggest new deepwater oil prospect, climbed 65% last year, leading gains in the S&P 500 Energy Index. That was its biggest annual increase since 2007.
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“Most of the outperformance is attributable to the company’s continued success offshore Guyana,” Muhammed Ghulam, a Houston-based analyst at Raymond James & Associates, said by email. The rally in Hess shares is poised to carry on “if it continues to see success” from drilling in Guyana and neighboring Suriname.
Hess outperformed every other stock in the S&P 500 Energy Index of 28 companies last year.
That was in stark contrast to index peers such as Occidental Petroleum Corp., which posted it steepest decline in two decades after the ill-received acquisition of Anadarko Petroleum Corp., and Cabot Oil & Gas Corp., which tumbled more than 20%.
For Hess, it was a remarkable turnaround from 2018 when the company led by Chief Executive Officer John Hess was targeted by activist investor Elliott Management Corp. for pursuing high-cost shale projects in the Bakken region of North Dakota.
“Hess has been on fire,” Paul Sankey, a New York-based analyst at Mizuho Securities USA, said in a note to clients. While much of the success in Guyana already is reflected in Hess’ stock price, the company could see further uplift when cash from the development begins to flow in, he said.
The genesis for Hess’ success was in 2014, when crashing oil prices spurred Royal Dutch Shell Plc to pull out of its 50-50 partnership with Exxon in Guyana.
That left the American supermajor in need of a new partner in its high-risk, wildcat drilling campaign in a region that had never before produced any oil.
Hess stepped in, as did China’s CNOOC Ltd., which bought a 25% stake.
It turned out to be one of the best bets of the century, with Exxon uncovering an oil deposit so massive that its boundaries have yet to be discerned. Exxon Senior Vice President Neil Chapman characterized the discovery as a “fairly tale” during a 2018 conference call.
In subsequent years, Exxon and its partners have made 14 more finds totaling more than 6 billion barrels. Commercial production began in late December even as exploratory drilling continues.
“At this point, we think production from Guyana developments over the next five or so years are in expectations,” Sankey said. “We would need to see more connection of Guyana operational success back to cash return growth to drive re-rating higher.”
The daily chart shows a move towards recent highs could be underway.
A Trade for Short Term Bulls
As with the ownership of any stock, buying HES 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.
A Specific Trade for HES
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 HES, the February 21 options allow a trader to gain exposure to the stock.
A February 21 $70 call option can be bought for about $3.42 and the February 21 $72.50 call could be sold for about $2.40. This trade would cost $1.02 to open, or $102 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 $102.
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 HES the maximum gain is $1.47 ($72.50 – $70= $2.50; $2.50 – $1.02 = $1.48). This represents $148 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $102 to open this trade.
That is a potential gain of about 44% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.