As the month was winding down, I felt like I was a little light in options income. Plus I’ve had a ton of positions expire this month (and three more expiring Friday), so the dry powder was burning a hole in my pocket.
Like everyone else, I feel like I’m waiting for the other shoe to drop. This market is bound to get interesting at some point right?
Anyway, I got a little ancy yesterday, so I pulled the trigger on this and one other trade that I’ll publish shortly.
HP recently went ex-div on 8/11/16, so we have until November before there’s another distribution to worry about. The company is a dividend champion, boasting an impressive record of 44 years of consecutive increases. The recent dividend increase from $0.6875/share to $0.70/share was pretty weak (1.8%), but life hasn’t been easy in the oil patch lately.
This trade will expire a couple weeks before the next ex-dividend date, and the premium exceeds the dividend distribution by 42%
The QC (Quantitative Case)
SPL (Strike Price Logic)
There are not a lot of strike prices available in the HP options chain. The strikes go in $5/share increments, which for a stock that is trading around $60ish per share are pretty big jumps. I had to go a little ways out in time (52 days), but I found a 12%+ annualized return with double digit downside protection.
There aren’t any particular visual support levels on the chart at $55. But it’s technically a 50% retracement of the rally from January 20th intraday low of $40.02 to the July 12th intraday high of $70.00, (well okay…$55.01 is the actual retracement level…close enough).
HP 1 year chart – courtesy Yahoo Finance
Do I believe in the fibonacci mumbo jumbo? Not really. The fact that I could find my strike price to be 50% of some arbitrary difference in the yearly chart is kind of fun, but ultimately probably insignificant.
The bottom line is that if I get assigned at this strike price, I think I will be getting shares below their intrinsic value. The strike also just so happens to represent a 5% forward yield.
QWaF (Qualitative Warm and Fuzzy)
Look, past performance does not guarantee future results, but the truth is that a lot of the warm and fuzzy has to do with this company’s historical performance over various cycles. The dividend growth track record, and the company’s reputation for being one of the higher end contractors in the industry means a lot. They are focused on the US land market, which keeps them from getting spread too thin, and they’ve been very conscientious about specifically investing in the technology needed for the newer more complicated shale wells that are the future of the US oil drilling market.
CPR (Cold and Prickly Risks)
That fleet, that is one of the most technologically advanced in the US market, is still mostly idle. Of their US land rigs, 91 are generating revenue, and 257 are stacked out (according to their latest earnings call). And believe me, they’re not the only ones with most of their rigs shut down. Across the industry there is an enormous amount of excess capacity. So even if we have hit bottom and oil is going to be coming back, day rates are going to be fiercely competitive. Management is hoping that they will be able to command higher rates because their technology is better suited for the more advanced horizontal projects. But the other guys are hungry too. It could take a while for the low-cost leaders to stumble around at lower day rates in the early stages of the cycle’s recovery.
To me that sounds like things might be flat for a while, which sucks, but is a lot more tolerable with a healthy dividend yield. My dividend cushion ratio is always calculated based on everything being flat, but the dividend continuing to grow. Because management hasn’t done anything stupid with the balance sheet, there is plenty of room for that to play out, which reinforces for me the idea that, like in previous cycles, they know what they’re doing.
Sign me up.