Recommendation No. 2: Chevron (NYSE: CVX)

“Sell to Open” Chevron June $110 Call

Option Symbol: CVX120616C110

Limit Order Price: $2.34 or more

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Income

• Income generated: $234 per options contract (representing 100 shares of stock)
• 86-day rate of return at current stock price of $107.91: 2.2 percent (9.2 percent annualized)
• Tell your broker:

“I want to sell a covered call against 100 shares of my Chevron (CVX) stock. Specifically, I want to ‘sell to open’ one June $110 call for a credit of $2.34 per share or more.”

• Remember: You should only sell one call option per 100 shares of stock purchased. The trade can only be done in 100-share increments (100, 200, 300, 400, 500, etc.).

Alternative Trade for Those Who Don’t Already Own Chevron:

Buy/Write on Chevron (NYSE: CVX): Buy the Stock and Simultaneously “Sell to Open” the June $110 Call

Option Symbol: CVX120616C110

Limit Order Price: $105.57 or less (stock is at $107.91 and June $110 call is at $2.34)

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Growth

• Net cost of buy/write: $10,557 per 100 shares
• 86-day return if stock does not move: 2.2 percent (9.2 percent annualized)
• Brokers vary as to whether they call this trade a “buy/write” or a “covered stock” trade.
• Do the trade simultaneously at a single limit price, if possible. For example, if you want to buy 100 shares of stock, tell your broker:

“I want to do a buy/write trade. Specifically, I want to buy 100 shares of Chevron (CVX) and ‘sell to open’ one June $110 call for a net debit of $105.57 per share or less.”

• Some brokers require that you buy the stock and sell the call in separate trades. If your broker is one of these, always buy the stock first and sell the call against it second:

Trade No. 1:

“I want to buy 100 shares of Chevron (CVX) for $107.91 per share or less.”

Trade No. 2:

“I want to sell a covered call against 100 shares of my Chevron (CVX) stock. Specifically, I want to ‘sell to open’ one June $110 call for a credit of $2.34 per share or more.”

• Ex-Dividend Date: The stock’s next quarterly ex-dividend date is around May 16th. If the June $110 call is in the money at that time, there is a chance the call holder will opt for early exercise to capture the $0.81 quarterly dividend, so an early roll of the covered call may be warranted. 
• Why the June $110 Strike?: According to Personal Finance associate editor Roger Conrad, Chevron is trading about 9 percent above his “buy below” price of $100 per share, so near-term upside from here is limited–especially given the litigation problems the company faces in Brazil, Ecuador and Nigeria over oil spills. I feel comfortable selling a covered call at the nearest call strike price above Chevron’s currently elevated price. High oil prices and Middle East tension are likely to keep Chevron’s stock price from falling much from now until June, so the stock appears to be in the perfect state of limbo for a covered call strategy.

Price Adjustments Regarding This Trade

Stock prices are currently fluctuating and option prices fluctuate with them. Consequently, the limit prices recommended in this trade alert may no longer be immediately fillable by the time the alert has been published. The alerts are valid for seven trading days, so please be patient and place your limit orders as “good ‘til cancelled” for seven trading days.

Investment Rationale for Underlying Stock:

Chevron focuses on oil production and is the “oiliest” of the big integrated oil companies. Its output is primarily sold at the price of Brent crude, rather than West Texas Intermediate crude, which continues to suffer from logistical constraints at the delivery point in Cushing, Oklahoma. That limits the company’s exposure to the weakness in North American natural gas prices.

Chevron expects to increase oil and gas production 20 percent to 3.3 million barrels by 2017, with a target to produce 3.3 million barrels of oil equivalent (BOE) per day, up from 2.6 million BOE by the end of this year. The company, which produces three-quarters of its BOE outside of the US, continues to rely on its massive Australian operations as well as its shale plays worldwide to drive this growth.

A majority of Chevron’s new production will come from its liquefied-natural-gas (LNG) complex in Australia. The project ramps up operations in 2014 and is expected to produce 40 trillion cubic feet of natural gas over 40 years.

Natural gas extracted from shale rock formations has grown to 25 percent of US gas production in just 10 years. And Chevron is the largest natural gas producer in the Marcellus Shale in Pennsylvania–operating about 100 wells–after it bought Atlas Energy last year for $4 billion. The company says that its Marcellus holdings have exceeded expectations and it plans to double their operations in that region.

Chevron has leases and concessions that cover about 8 million acres of the world’s shale locations. The company has operations in every populated continent and recently began drilling its first well in China in early 2012.

From a financial perspective, Chevron continues to distance itself–in a positive way–from its big oil peers. In 2011, Chevron achieved record earnings and operating cash flow. Earnings for the year were $27 billion, over 40 percent higher than in 2010. Operating cash flow was $41 billion, 30 percent more than in 2010.

Most of the oil industry last experienced record operating cash flow in 2008, when oil prices hit their peak. By contrast, Chevron’s 2011 operating cash flow was 39 percent higher than three years ago. In the energy industry–or any other industry–companies that manage to outperform their peers are the best investments.

Chevron is rated as a “buy under 100” in the Personal Finance Income Portfolio.