Idea in XOM

Recently XOM has had about a 10 point selloff since its announcement of the acquisition of XTO for about $30 billion in a all stock deal. It is normal for the acquirer to decrease in price while at the same time for the target to increase in price. But in my opinion XOM is already undervalued if you look just a little bit in the future. Last year they saw profits collapse and saw record profits the year before that. Oil went to $147 in 2008 and sank as low as $33 in 2009. It has since recovered and is currently trading around $79 as I write this blog.

Some will argue that a chunk of the increase in crude is due to a weak dollar and that the fundamentals do not support the price (i.e Supply and Demand). And I can't say that I don't agree, but I don't agree entirely. What I mean is that stock prices do not care about the here and now as that is now the past. They care about what is going to happen in the future. And that is really what the stock price should reflect. So if you believe in the recovery and you think that higher oil prices are here to stay than there is no reason that you should not be looking at oil companies.

I am looking at XOM in particular as it is the best in bread and also because the market has presented a nice entry into this name. If you look at a chart the lowest price in the past two years is about $57 and the 52 week low stands about $62. Not that I am saying that the past is any indication of the future but these are the frames of references that we have to work with. Since the recent sell off it looks as if XOM has found some support at about $68, the next level of support is at $66 and then about $60.

This year XOM is expected to earn about $3.90 per share and with the current price at about $69 that puts a p/e of about 17.69. Next year as oil prices are forecasted to be $75-$100 EPS are forecasted at about $5.80 putting this stock at a p/e of 11.89. Which is a steal of a deal. Now all of these forecast are based on the assumption that the recovery continues through 2010. So you kind of have to make you bet.

With that said I am looking to initiate a position in XOM. As I have been more inclined to sell puts I am looking at selling the Jan '12 $65 puts for around $8.10 per contract. Now you may ask yourself why go so far out in the future. One is it gives my position time to work. It also gives me a large margin of safety. It is not that I really intend to ever really be in the position for that long. With that said I am not going to put on the position just yet, I would like to see how you guys would play it if you were bullish on oil. What strategy would you use? How much time would you give the position to work? What contingencies might you have?


Position:

Today I initiated a position in XOM (Currently at $68.90) by selling the ITM $85 strike put with Jan '12 expiration. As I am bullish on Oil prices going into next year and feel confident with analyst estimates of XOM earning $5.80 a share I think that XOM is undervalued. I am comfortable using a 15 multiple to get a price target for XOM which puts this thing worth $87 a share. You also have to look at the fact that this stock is trading where at close to the same price as when oil was at $33. I think there will be some catch. There is also the XTO acqusition.

What do the probabilities and the Greeks look like?

I am including the Greeks now as I am trying to include them in my trading analysis and position selection. As you may notice with most of my positions that I have been posting about, I never really enter a position with the intention to capture the entire profit potential. Instead I will shoot for a bunch of singles and doubles as this is what fits my risk tolerance right now. My time frame is longer than a day, but I would be suprised if I hold this position past three months.

For now most of my trades are playing the greek Delta. As noted above I have slapped a $85 price target on this baby. So why is the Delta on this particular option. Well ITM options have a delta closer to 1 than OTM option. So with a Delta of $0.78 this means that every point move to the upside that XOM makes this option will move $0.78 or $78 in my favor. So a $10 move would put me in the money by $780, if, and I bold this because this is the big caveat, everything else meaning the other greeks remain constant. Which they all change over time, but this gives a ruff estimate.

What does the chart look like?

Notice the recent selloff. This presents good entry for new positions in my opinion. Looks like investers were able to support the price at about $68. Also notice that the 53 week low is around $62 and it hasn't traded much lower than $57 in the past two years. Like I have said before, not that the past is an indication of the future, but it is a base in which to start from.

Onn.tv XOM April '10 75/80 vertical spread

Here are the probabilities for XOM in this vertical spread idea. As I mentioned it is going to cost about $0.60 per spread for a potential reward of $4.40 per contract or 733%. But as you can see based on the probabilities there is a trade off for such a nice return. The likely hood that it reaches the $80 target is 15.94% . So from here you have to make your bets as what kinds of catalyst will get XOM to hit targets and how confident do you feel. But other than that it is a cheap bet so if you are wrong it is not that much money.

If you have any questions on how to interpret the probabilities, just ask me.