Here is how I plan on trading Denbury Resources [stock_quote symbol=dnr] moving forward. I believe DNR is headed higher over the next few years. It may take until 2018, but it will move higher as crude oil recovers – which it will. However, currently I’m hesitant to allocate too much cash to the cause. and I’m worried about earnings this week (before the market opens on Thursday, August 4, 2016). I’m also worried about the continued decrease in oil prices over the next few months.
SO WHAT DO I DO?
Well, I currently hold many DNR positions including 2000 shares of stock, 10 contracts of the AUG 3 PUT (protection for stock before I bought another 1000 shares), another 10 contracts of the SEPT 2.5 CALL, another 10 contracts of the SEPT 3 CALL and yet another 10 contracts of the SEPT 4.5 PUT that I sold for a 30% premium (just in case it takes off). I’m down roughly $1800.00 on what I hold, but I consider this a long-term play and I always knew I would exercise my calls if nothing else and sit on the stock.
IS THIS THE SMARTEST TRADE?
No. In fact, I was running numbers this morning and determined if I really believe DNR is headed higher over the next few years and I do not want to be over-exposed to the market or allocate large sums of cash then my best trade is to buy long-term DITM calls for 2018.
Next week I will be monitoring DNR closely. I will be looking for an exit for my call positions and plan to hold my current stock as-is. I am confident we will see a pullback after earnings, but in true earnings fashion we may see a rally before and up-to the release date. This could be a good time to exit some of my positions.
I will be buying a minimum of thirty (30) JAN 2018 3 CALL options for a total of 3000 shares worth bringing my potential total to 5000 shares. I would like to have 100 contracts (10,000 shares worth), but I’m going to patiently wait and watch throughout August and September and buy the JAN 2018 3 CALL options down if the underlying stock price continues to drop.
By making this trade I will have control of the total number of shares I really want to have (10,000), yet, it will only require a fraction of the cash allocation compared to buying actual stock. Some might say this is the entire purpose of options!
Currently the DNR JAN 2018 2 CALL (I’m using the $2.00 strike here because I know the value of the option off the top of my head, I would be more interested in the $3.00 strike to save a little money on the premium) is selling for $1.48 per contract. The break-even in January 2018 would be $3.48 ($2.00 strike plus the $1.48 we paid)and I’m damn sure the stock will be higher than that or the company will be bankrupt one of the two.
If I went ahead and purchased all 100 contracts to capture 10,000 shares worth the trade would cost $14,800.00 compared to $29,000.00 if I bought the stock outright at Friday’s closing price. I would only have half the amount of cash allocated to control the same number of shares. Sweet!
You could also execute a collar / synthetic (combo) scenario by selling JAN 2018 put options to help pay for buying the JAN 2018 call options.
For example: I could sell the JAN 2018 3 PUT @ $1.25 per contract for 5000 shares or 50 contracts. That would be a premium of $6,250.00. Then turn around and buy 50 contracts or 5000 shares worth of the JAN 2018 3 CALL @ 1.20 per contract costing $6,000.00. This would be a net credit of .05 cents.
Ultimately, the trade would cost us nothing and as long as the stock price is above $2.95 per share in January 2018 we are slick. The break-even on the PUT option leg alone would be $1.75 per share. I could live with that! If the stock sees a drastic move up your profit will be capped with the PUT option, but infinite with the call options.
QUESTIONS OR CONCERNS? DID I SCREW UP?
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