After surviving a near-bankruptcy experience in 2015-16, many investors didn’t expect Chesapeake Energy to file Chapter 11 as it just recently announced. And it’s not Chesapeake shares that we are interested in, but rather the shares of a midstream provider that derives 6% of its revenues from Chesapeake. Volatility has spiked, and fear has already caused the shares to sell off a little farther than they should have, in our view. As a result, this attractive high-income options trade opportunity has emerged. We believe this is an attractive trade to place today and potentially over the next few days, as long as the underlying stock price doesn’t move too dramatically before then.
The blue line in the chart above is the year-to-date total return of energy infrastructure company, The Williams Companies (WMB).
The Trade: The Williams Companies (WMB)
Sell Put Options on The Williams Companies (WMB) with a strike price of $17.00 (~7.5% out of the money), and an expiration date of July 17, 2020, and for a premium of $0.25 (this comes out to 1.5% of extra income in just half a month, ($0.25/$17.00) and that’s over 35% of extra income on your money on an annualized basis (2 x 12 months x 1.5%). This trade not only generates attractive income for us now, but it gives us the possibility of owning shares of WMB at an even lower price if the shares fall even further than they already recently have, and they get put to us (and we’d be happy to own WMB especially if it falls to a purchase price of $17.00 per share).
(note: investors might also consider the $17.50 or $16.50 strikes if they want a higher or lower change of the shares being put to them.
Your Opportunity:
We believe this is an attractive trade to place today and potentially over the next few days as long as the price of WMB doesn't move too dramatically before then, and as long as you’re able to generate annualized premium (income for selling, divided by strike price, annualized) of approximately 30%, or greater.
Our Thesis:
Our thesis is basically that despite the Chesapeake bankruptcy, and despite low energy prices this year, the volume of natural gas (and to a lesser extent, the amount oil) transported through WMB’s infrastructure will not change dramatically. And the long-term contractual fixed fees WMB gets paid for transporting it will not change dramatically either. WMB has already disclosed that only 6% of its revenues come from Chesapeake (down from 18% 5 years ago), and the according to WMB VP Laura Creekmur, WMB is:
“confident in our ability to defend the integrity of our contracts," as its pipelines remain integral to "maximize the value" of Chesapeake's assets.
Chesapeake is filing Chapter 11 bankruptcy, which is a reorganization and means the company will continue to operate post bankruptcy. The company is rumored to be seeking the cancellation of some pipeline contracts, however this will be settled in the courts likely in a way that is a compromise between Chesapeake, pipeline companies and the industry in general.
Overall, we believe Chesapeake is a small part of WMB’s business, the nature of the pipeline usage will allow it to continue post chapter 11, and the shares are simply too inexpensive now relative to the long-term value of WMB’s infrastructure and long-term fixed rate contracts. You can read our previous report on WMB HERE (and worth noting, the company did announce expectation meeting earnings post that report, as the business is well positioned to power through current industry challenges. Also worth noting, we are currently long WMB shares.
Important Trade Considerations:
Please also keep in mind, options contracts trade in lots of 100, so to secure this trade with cash (in case the shares get put to you and you have to buy them) you’ll need to keep $17 times 100 on hand (the strike price times an options contract lot of 100). You’ll also need to be comfortable holding that many shares in your account from a position-sizing / risk management standpoint (WMB’s low share price makes this trade easier to enter at a lower total dollar amount). Alternatively, if your account is approved for margin (borrowing) you don’t need to keep the cash on hand in case the shares get put to you, just know that if they do get put to you—you’ll buy them “on margin” and get charged the borrowing interest rate in your account (some investors are okay with this, others simply prefer to keep the cash on hand) if you don’t have enough cash in your account to settle up.
Two additional considerations when selling put options are dividends and earnings announcements because they can both impact the share price and thereby impact your trade. In this particular case, they are both largely non-issues. Specifically, WMB isn’t expected to announce earnings again until the end of July (after this contract expires), and it won’t go ex-dividend again until September (also after this options contract expires). Had either of these taken place before this options contract expired, then we’d need to be comfortable that the upfront premium adequately compensated us for the potential increase in share price volatility.
Conclusion:
We believe The Williams companies will survive the current energy market challenges, including the impacts of the Chesapeake bankruptcy and the challenges of the coronavirus lockdowns. We also believe the upfront premium income available on this options trade is highly attractive. Furthermore, the 8.7% dividend yield the shares currently offer is attractive.
If you are uncertain about pulling the trigger on a normal buy order for WMB, you might consider this trade instead. It allows you to generate attractive upfront premium income that you get to keep no matter what. And this options trade also gives you a chance of picking up shares of this attractive long-term energy infrastructure company at an even lower price, if the shares fall even further than they already recently have, and they get put to you at $17. And at a price of $17, WMB is an extremely attractive long-term income investment.