Energy giant ExxonMobil (NYSE:XOM) announced Q1 results in late April. Since the early days of the pandemic, oil and gas companies have been in the spotlight for investors. Recently, the optimism surrounding the reopening of global economies as well as recovering crude prices have provided tailwinds for the sector after a rough patch during 2020.
So far in 2021, XOM shares are up about 41%. In March, they hit a 52-week high of $62.55. Now, the stock is hovering at $59.10.
Given the recent surge in the XOM share price, some investors are now debating whether profit-taking could soon pressure the stock. Meanwhile, others who have not invested in Exxon earlier in the year are wondering if they might have a chance to buy into the share price at a cheaper level in the near future.
In previous weeks, we've discussed how investors could consider setting up covered calls. One of the stocks we covered in mid-April was Exxon, when the share price was at $55.50.
Today's article looks at XOM stock in light of the most recent Q1 earnings and discusses how investors could consider selling cash-secured put options on Exxon. Such a trade could especially appeal to investors who want to receive premiums (from put selling) or to potentially own XOM stock for less than its current market price (of $59.10 as we write on Tuesday).
Since we have not discussed the topic of put selling before, this article will introduce several concepts that might be new for some readers, but possibly repetitive for others. Those who are new to options might want to read the previous covered call article on XOM so that they can better appreciate the differences between the two type of trades.
ExxonMobil Q1 Earnings
- Intraday Price: $58.80
- 52-Week Range: $31.11 - $62.55
- Dividend yield: 5.93%
- Year-To-Date Price Change: Up about 42%
Exxon, whose history goes back to the second half of the 19th century, is one of the most important oil majors. On Apr. 30, the group announced Q1 2021 figures.
Revenue came in at $59.15 billion. A year ago, it had been $56.16 billion. Net earnings of $2.7 billion translated into EPS of 64 cents. In Q1 2020, the energy supermajor had recorded a loss of $610 million (or loss of 14 cents per share). During the quarter, cash flow from operations was $9.2 billion.
At the time, CEO Darren Woods said:
“The strong first quarter results reflect the benefits of higher commodity prices and our focus on structural cost reductions, while prioritizing investments in assets with a low cost of supply.”
XOM stock’s forward P/E and P/S ratios are 18.52 and 1.37, respectively. As we have discussed in previous articles, fortunes of oil companies like ExxonMobil depend heavily on the price of crude oil, which comes in different grades. The global benchmark is Brent crude (currently ~$68.5) and the U.S. benchmark is West Texas Intermediate, WTI, (currently ~$65.2). In the early days of the pandemic, during March 2020, both dropped to the $20 level.
What Is A Put Option?
A put option on a stock (such as XOM) is a contract that gives the owner (or the buyer) the right, but not the requirement, to sell that stock at a predetermined price (or the strike price), by a specific date of expiry.
However, put sellers (or writers) have the obligation to buy the (XOM) stock at the strike price of the option if the buyer decides to exercise the option.
In simple terms, a put option increases in value as a stock falls (in real life, there are several parts to the equation to determine the price of an option).
Investors might consider buying put options on a security (XOM stock in this case), when they expect the price of ExxonMobil to fall. They usually regard the put option as a hedge (or insurance) in the case of a large drop.
Put buyers could lose the premium they have paid for buying the option, if they are wrong in their market view (i..e, if the price of XOM stock does not fall enough to cover the premium they have paid).
Put sellers stand to lose money if the stock price falls as they would need to buy (XOM) stock at the strike price but can only sell it at a lower price.
One way to think about a put option is to consider an insurance transaction (such as car or house insurance). As the writer (seller) of an insurance product, the insurance company gets paid a certain amount of premium for a number of months (similar to the “expiration date” of the put option). The insurance buyer is ready to pay the premium as a hedge in the case of an unforeseen loss (such as damage to a car or house).
In return, the insurance company assumes certain obligations. For example, if the insured car is damaged in an accident, the car insurance group would need to be able to pay a certain amount to the buyer (holder) of the insurance.
The way insurance products serve an important purpose in terms of risk transfer, put options have numerous similar uses in financial markets.
Selling Cash-Secured Puts On XOM Stock
Those investors who write cash-secured puts are typically bullish on a stock during the time frame until the option expiry date. They generally want one of two thing, either to:
- generate income (through the premium received by selling the put), or
- own a particular stock, say XOM, but find the current market price (i.e., $59.10 for XOM now) higher than what they'd like to pay.
Cash-secured means the investor has enough money in the brokerage account to purchase the security (or XOM stock) if the price of the stock falls and the option is assigned.
One put option contract on XOM stock is the option to sell 100 shares. In other words, the seller of the put option should have enough money in their brokerage account to buy 100 shares of that stock at the strike price.
This cash reserve must remain in the account until the option position is closed, expires, or the option is assigned.
Let’s assume an investor wants to buy XOM stock, but does not want to pay the full price of $59.10 per share as of today. Instead the investor would prefer buying the shares at a discount of about 5%-8% within 6-8 weeks.
One possibility is to wait for XOM stock to fall (which it might or might not do). The other possibility is to sell 1 contract of a cash-secured XOM put option.
As a result, the put seller would take on the obligation to potentially buy 100 shares of XOM at a certain price (the strike price) by the expiry date, and get paid a certain amount of premium now for taking on that obligation.
So the trader would typically write an at-the-money (ATM) or out-of-the-money (OTM) XOM put option and simultaneously set aside enough cash to buy 100 shares of XOM stock.
Let’s assume the trader is putting on this trade until the expiry date of June 18. As XOM stock is currently $59.10, an OTM put option would have a strike of 57.50. The seller would have to buy 100 shares of XOM at $57.50 if the option buyer were to exercise the option to assign it to the seller.
The XOM June 18, 2021, 57.50-strike put option is currently offered at a price (or premium) of $2.06.
An option buyer would have to pay $2.06 X 100, or $206, in premium to the option seller. This premium amount belongs to the option writer (seller) no matter what happens in the future, i.e. until or on the day of expiry. This put option will stop trading on Friday, June 18, 2021.
Risk/Reward Profile For Unmonitored Cash-Secured Put Selling
Assuming a trader would now enter this cash-secured put option trade at $59.10, at expiration on June 18, the maximum return for the seller would be $206, excluding trading commissions and costs.
The seller’s maximum gain is this premium amount if XOM stock closes above the strike price of $57.50. In that case, the option expires worthless.
If the put option is in the money (meaning the market price of XOM stock is lower than the strike price of $57.50) any time before or at expiration on June 18, this put option can be assigned, and the seller would be obligated to buy 100 shares of XOM stock at the put option's strike price of $57.50 (i.e. at a total of $5,750).
The break-even point for our example is the strike price ($57.50) less the option premium received ($2.06), i.e., $55.44. This is the price at which the seller would start to incur a loss.
On a final note, the calculation of the maximum loss assumes the put seller was assigned the option and purchased 100 shares of XOM at the strike price of $57.50. Then, in theory XOM stock could fall to zero.
Once the put seller gets assigned the option, the maximum risk is similar to that of stock ownership, but partially offset by the premium (of $206) received.
Bottom Line
Cash-secured put selling is a moderately more conservative strategy than buying shares of a stock such as XOM outright at the current market price. But, as seasoned investors would concur, there are no free lunches on Wall Street.
This strategy might be appropriate for investors who want to buy (or at least do not mind buying) high-quality companies at a price that is lower than the current price. Interested investors might want to refer to the educational website of the the Options Industry Council (OIC).