A Safer Option for Would Be Chesapeake Investors
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
“If the only tool you have is a hammer, you tend to see every problem as a nail.” – Abraham Maslow
You are missing out, and for the longest time I was too. As an investor I had but one tool to use in building a solid investment portfolio. It was a fine tool, got the job done as best as it could but at times it just wasn’t what I needed.
Like you, I want to own great businesses but all too often those great businesses are not selling for great prices. I don’t always have the patience, or the time to wait for that great business to sell for even a fair price. So in my excitement I buy, and my returns suffer. The only real tool I had was to buy or to sell. Like a hammer I could pound a stock into my portfolio or pull it back out. My options were really limited, because I simply hadn’t considered all my options.
There is another tool that I think that every investor should learn how to use. By learning how to strategically use options on a business you know well enables you do so much more with your portfolio than you’d ever dreamed. They give you the ability to invest less capital or buy stocks cheaper and if nothing else earn some income while trying. Who doesn’t want to earn a little extra income just for trying?
Options also give you the ability to take a position in a company you’re just not very comfortable buying at today’s prices. For example, I’ve made it no secret, I’m not the biggest fan of Chesapeake Energy (NYSE: CHK). However, I do think that they own some great assets and if they can turn some things around, the company could be worth a whole lot more. With options I can really reduce my investment risk, but first, why would I even think that Chesapeake should even be considered?
They simply have some of the best positions in some of the most promising production basins. Take their Eagle Ford position which is right in the oil window of the play. In the second quarter 66% of their production in the play was oil. They have the second largest acreage position to EOG (NYSE: EOG) which like Chesapeake has a bulk of their acres in the oil window. They’re producing 78% oil from their wells and have called the play their best asset in North America. EOG’s a great company so that’s saying something about what Chesapeake has in terms of the long term value of that asset.
Or take a look at their Utica Shale position in Ohio where they have a large position in the oil window of that play as well. Just recently Gulfport Energy (NASDAQ: GPOR), which calls the Utica one of the most promising up-and-coming oil-levered plays in North America, brought their first well online with exceptional results. Like Gulfport, Chesapeake’s been seeing great results from their wells in this really exciting emerging production basin. The list goes on, but you get the idea. Chesapeake’s doesn’t just have acreage in these shale plays, they have prime positions.
Finally, Chesapeake has been repositioning their assets by trading non-core assets for cash. They recently sold off their stake in Access Midstream (NYSE: ACMP) for $4 billion while signing up joint venture partners at a rapid pace. Their Utica partner for example is French energy giant Total (NYSE: TOT) which paid them $2.32 billion for a 25% stake in their Utica acres. They’ve partnered with several other international oil companies throughout their operational basins. These partnerships bring in both expertise and cash which reduces Chesapeake’s risk.
Still, with their big debt pile and image problem a lot of risk remains. In order to reduce investment risk in terms of capital at risk I have several options to consider but let me offer two for simplicity’s sake. Let’s say you’d only buy Chesapeake if someone paid you to do so and shares were dirt cheap. Believe it or not with options you can potentially buy 100 shares more than 20% cheaper and get paid nearly $100 dollars to do so by simply writing January 2013 $15 puts.
Or if $1,500 is too much for you to risk on such an unstable entity you can buy calls instead. This reduces your risk by limiting your downside to what you pay for the call. You’d still control 100 shares but instead of investing $1,900 today if you bought shares or $1,500 by writing puts you can buy January 2014 $15 calls for $685. If Chesapeake for some reason went bankrupt, your losses would be limited to just a third of what it would be if you bought shares, yet you’d have unlimited profits over $22 a share.
Options get a bad rap, but as you can see they can be a very valuable tool to invest less capital or buy stocks cheaper and earn some income while you’re at it. If you want to build a portfolio that’ll stand the test of time, you’ll need more than just one tool. It’s understandably daunting to use any tool without the proper training, never be afraid to learn and before you know it, you’ll be a whiz.
latimerburned has no positions in the stocks mentioned above. The Motley Fool has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2013 $25.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Motley Fool newsletter services recommend Total SA. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.