Options: Trade Set Up in Occidental Petroleum
A number of forces are at work creating a volatile energy market, which has moved higher for the majority of 2010. On one side you have the FOMC introducing a second asset purchase program that is directed at increase inflation and asset prices. One the other side you have the Chinese government who is raising interest rates and creating price curbs in an effort to keep prices from rising.
With oil prices climbing to a new range above $80 per barrel, companies that have exposure to the oil markets should continue to improve.
Occidental Petroleum is an robust company that has the majority of its exposure to upstream oil, exploration and production. Occidental’s low cost structure and use of enhanced oil-recovery techniques to increase production and build reserves will enable it to maintain strong cash flow and profitability in almost any price environment.
Key drivers of OXY’s 2H10 growth are be the increase of California volumes as additional upstream processing capacity comes online; exploration/exploitation drilling results in its properties in California; and the start of operations at a new plant in the Permian Basin by year-end, which should benefit Enhanced Oil Recovery volumes beginning in 2011.
Oil prices play a large role in driving the price of OXY. The company management believes that prices above $55 dollar a barrel create positive cash flow for the company. With prices near $80, and potential rising, the outlook could be as high as a stock price near $90.
Strong growth in global oil consumption, and the expectation that it may continue, is one factor that has contributed to recent crude oil price increases. Continued growth in global GDP (weighted by oil consumption) is 3.9 percent in 2010, according to the Department of Energy. Economic growth this year, particularly in China, is one of the reasons the EIA now expects global petroleum consumption to grow 2.0 million barrels per day (the second highest annual growth rate in at least the last decade).
Recent inventory data in the US has also been a positive for oil. In its latest reading, oil inventories within the United States dropped nearly 7 million barrel, compared to expectations of a drop of 100 thousand barrels. This data is normally, volatile, but the trajectory of the drop is impressive. Additionally, the overhang in oil within the US is declining, and although the day’s supply of oil is still relatively high, it continues to show improvement.
Technically, OXY looks strong and continues to test the $88 dollar level. There are numerous resistance levels from long and short term weekly trend lines, that need to be breached for OXY to continue to move higher. Trading in the company should be predicated on a daily close above $89. This should lead to a weekly test of $91.
This is a strategy in which the investor purchases (or sells) a call option and simultaneously sells a put (or purchases). The risk on the trade is that the markets heads south and you are left short a put as the market moves lower.
The February $95 call and $80 put are currently a credit to the put. This means that if you purchases a ($95 – $80) collar, you would receive a credit. By the time the market moves to a technical breakout level of $89, the credit will evaporate, but you should be able to purchase the collar for zero cost. If the market heads higher, you can take profit on the collar when OXY approaches $95. A close between $95 and $80 on at expiration will risk zero capital. If the markets breaks through $80, and investor could look to exit the trade.
Disclosure: No positions.