Chevron Corp (CVX) delivered strong Q2 results on July 28. However, its cash flow, although positive, came in lower than the prior year. This has led to a drop in CVX stock to $160.76 as of Aug. 9 morning trading, down from $163.66 on July 31.
However, recent large out-of-the-money put options activity, as seen in today's Unusual Stock Options Activity Report from Barchart shows that there are still ways to play this weakness.
That Report shows a prominent investor(s) either bought or sold deep out-of-the-money (OTM) put options that expire on Oct. 20, 2023, 72 days from now. There were over 10,000 put contracts traded today at the $145 strike price, which is $15.76 below today's price, or 9.80% out-of-the-money. The average premium was $1.66 per put option contract.
Often when that happens you get a mix of pessimistic investors who truly believe that it is worth going long this put. But, in that case, they won't make any money unless CVX stock falls below $143.34 (i.e., $145-$1.66), or 10.8% from today.
Note that this activity is unusual since the number of contracts traded is over 29x the normal outstanding contracts (open interest), as seen in the 29.14 Vol/OI column.
Short Put Scenario Most Likely
However, the most likely scenario is that the initiating trades were from short sellers of these OTM puts. They are taking advantage of the high put premium. For example, by selling these puts on a cash-secured basis as a “Sell to Open” trade, the traders collect $1.66 on an investment at $145 per share.
That works out to a yield-to-put-strike price of 1.14% (i.e., $1.66/$1.45). For example, for every 1,000 put contracts they shorted, after securing $14.5 million with the brokerage firm, the trader immediately collects $166,000. As a result, they make 1.14% with just 72 days until expiration.
What is likely to happen is that unless CVX stock drops dramatically, especially in the last 30 days until expiration, the premium will fall from $1.66 to a much lower number. At that point, the trader can enter an order to “Buy to Close."
You can see the appeal here. For one, if the trader repeats this trade every 72 days, i.e., 5 times a year, they make an annualized return of 5.7% (i.e., 1.14% x 5). But more importantly, if the trader is already long CVX stock, they get to enhance the already high dividend yield.
CVX Stock Upside
Chevron pays $6.04 annually in dividends and the company is likely to raise the dividend per share after the next payment. So its yield, presently at 3.75%, is likely to approach 4.0% by the end of the year, or even by the expiration of this put contract.
That provides a solid base for the company's present stock price and could propel it even further. As a result, the short-put trader, if they are long CVX stock can enhance their yield by shorting these OTM puts.
One reason for this is that the company's cash flow from operations (CFFO) is very strong, despite the lower oil and gas prices it has been receiving. For example, in Q2 it produced $9.4 billion in CFFO before working capital changes.
That was more than enough to cover the Q2 dividend cost of $2.8 billion and the large buybacks of $4.4 billion it made (i.e., $7.2 billion total). This can be seen on page 10 of its earnings release in the Summarized Statement of Cash Flows. In fact, it also paid down $1.6 billion of its debt on a net basis.
So, given that the dividend is secure, and given the stock's high dividend yield and the prospect of another increase, CVX stock has a good potential upside. For example, Chevron has raised its dividend every year for the past 35 years, according to Seeking Alpha.
Moreover, its average dividend yield over the last 5 years has been 2.63%. This implies that with the present dividend of $6.04, CVX stock should be trading at $229.66 (i.e., $6.04/0.0263). That shows that CVX stock could potentially rise 43% or more from today.
Therefore, this is why an investor likely shorted large amounts of CVX puts today at the $145 strike price for expiration on Oct. 20.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
