ExxonMobil (XOM) stock still looks undervalued based on analysts' price targets and average dividend yield. As a result, shorting out-of-the-money (OTM) put options is a good way to generate income and set a buy-in target price.
That makes XOM very attractive to value investors. It may be boring, but the stock still looks cheap based on its cash flow and dividend yield.
XOM was at $109.51 on Tuesday, Feb. 25, down from its recent high of $121.93 on Nov. 21. I discussed XOM stock's value in a Feb. 3 Barchart article titled “ExxonMobil Gushes Huge Cash Flow, Albeit at Lower Levels—Is it Time to Buy?”
The article will show one way to play this by selling short out-of-the-money (OTM) puts in nearby expiry periods.
What XOM Could Be Worth
I suggested XOM was worth at least $113.47 per share, based on its historical dividend yield. For example, the average yield in the past three years has been 3.49%, based on Morningstar data for the annual yield averages.
But today its yield is higher at 3.61%: $3.96 dividend per share (DPS) / $109.51 = 0.0361 = 3.61%
Therefore, using its average 3-year yield, XOM could rise by almost 4% :
$3.96 DPS / 0.0349 = $113.47
$113.47 / $109.51 = +3.6%
Moreover, using its lowest yield of 3.22%, XOM could rise by +13% to $123.75:
$3.96 DPS / 0.0322 = $123.75
$123.75 / $109.51 = 1.13 = +13.0%
Analysts also agree. For example, Yahoo! Finance reports that the average of 28 analysts' price targets is $129.25, and Barchart says its survey has a mean target of $129.58.
This shows that there could be a good upside in XOM. One way to play this is to sell short out-of-the-money puts in nearby expiry periods.
Shorting OTM Puts
In my last Barchart article on Feb. 3, I discussed selling short the $102 strike-price put options expiring March 7. At the time the premium was $1.37 in the midpoint, providing an immediate yield of 1.343% (i.e., $1.37/$102.00 = 0.01343).
Today, those puts are selling for just 18 cents on the ask side. So, most of the income from this cash-secured short-put play has been made. It makes sense to roll it over.
For example, look at the March 28 expiration period, one month away - 31 days to expiry (DTE). The $106 put exercise price, 3% below today's trading price, has a midpoint premium of $1.46 per put contract.
That provides the short seller an immediate yield of 1.377% (i.e., $1.46/$106.00). Even after buying to cover the 18 cents premium from the March 7 put trade, the net yield is 1.21% (i.e., $1.28/106.00 = 0.01207).
This means that an investor who secures $10,600 with their brokerage firm can do this trade. After entering an order to “Sell to Open” the March 28 $106 put and a trade to “Buy to Close” the March 7 $102 put trade, the account will receive approximately a net $128.00. That works out to 1.2% of the net $10,600 invested in this play.
As long as XOM stock stays over $106.00 for the next month the account will not be assigned to buy 100 shares at $106.00. Even if that happens, the net purchase price is $106-$1.28, or $104.72. That provides the long-term investor a good buy-in price. For example, the yield at that point is:
$3.96/$104.72 = 0.07815 = 3.78%
In other words, the investor can generate a good yield using this buy-in play. Moreover, by repeating the trade each month the investor has an expected return (ER) of 16.52% annually (i.e., 1.377% each month x 12). This assumes that the investor makes the same yield each month. The total expected return is over 20% (i.e., 16.52% ER+3.78% dividend yield = 20.3%).
The bottom line is that value investors love XOM stock here, based on its average yield, analysts' price targets, and short OTM put plays that can generate extra income.
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.
