Suncor Energy (NYSE:SU) is one of Canada's largest integrated energy companies that operates "across the entire petroleum value chain—from oil exploration and production to transport, refining and marketing."
In terms of crude oil storage in Canada, it has more than a 50% market share. In addition, its refineries are among the most efficient.
So far in the year, Suncor shares returned over 42% and hit a multi-year high in mid-June. Investors have been pleased with the Q1 results announced on May 3. Analysts concur the business should continue to generate strong free cash flow. As we start the second half of 2021, inflation expectations remain high, and provide tailwinds to a bullish outlook on the energy sector.
Therefore, today, we look at SU stock to see how investors could consider selling cash-secured put options on the company. Such a trade could especially appeal to those who want to receive premiums (from put selling) or to potentially own Suncor Energy shares for less than its current market price of $23.72, as we write on Tuesday. In terms of 12-month price forecasts, the median target is $29.
We previously discussed the detailed mechanics of cash-secured put selling using ExxonMobil (NYSE:XOM) stock. Readers who are new to put selling may want to consider reviewing that article.
Selling Cash-Secured Puts On SU Stock
Investors who write cash-secured puts are typically bullish on a stock like Suncor Energy during the timeframe that extends to the option expiry date. They generally want one of two things. Either to:
1. Generate income (through the premium received by selling the put), or
2. Own the stock, but find the current market price per share (i.e., $23.72 for SU now) higher than what they'd like to pay.
One put option contract on SU stock is the option to sell 100 shares. Cash-secured means the investor has enough money in the brokerage account to purchase the security if the stock price falls and the option is assigned.
This cash reserve must remain in the account until the option position is closed, expires or the option is assigned, which means ownership has been transferred.
Let's assume an investor wants to buy SU stock, but does not want to pay the full price of $23.72 per share. Instead, the investor would prefer buying the shares at a discount in the next six to 10 weeks.
One possibility is to wait for Suncor Energy stock to fall, which it might or might not do. The other possibility is to sell one contract of a cash-secured SU put option.
As a result, the put seller would take on the obligation to potentially buy 100 shares of SU at a certain price (the strike price) by the expiry date, and get paid a certain amount of premium now for taking on that obligation.
So the trader would typically write an at-the-money (ATM) or out-of-the-money (OTM) SU put option and simultaneously set aside enough cash to buy 100 shares of SU stock.
Let's assume the trader is putting on this trade until the option expiry date of Sept.17. As SU stock is currently $23.72, an OTM put option would have a strike of 23. The seller would have to buy 100 shares of SU at $23.00 if the option buyer were to exercise the option to assign it to the seller.
The SU Sept. 17, 2021, 23-strike put option is currently offered at a price (or premium) of $1.23.
An option buyer would have to pay $1.23 X 100, or $123 in premium to the option seller. This premium amount belongs to the option writer (seller) no matter what happens in the future, i.e. until or on the day of expiry. This put option will stop trading on Friday, Sept. 17, 2021.
Risk/Reward Profile For Unmonitored Cash-Secured Put Selling
Assuming a trader would now enter this cash-secured put option trade at $23.72, at expiration on Sept. 17, the maximum return for the seller would be $123, excluding trading commissions and costs.
The seller's maximum gain is this premium amount if SU stock closes above the strike price of $23.00. Should that happen, the option expires worthless.
If the put option is in the money (meaning the market price of SU stock is lower than the strike price of $23.00) any time before or at expiration on Sept.17, this put option can be assigned, and the seller would be obligated to buy 100 shares of Suncor stock at the put option's strike price of $23.00 (i.e., at a total of $2,300).
The break-even point for our example is the strike price ($23.00) less the option premium received ($1.23), i.e., $21.77. This is the price at which the seller would start to incur a loss.
On a final note, the calculation of the maximum loss assumes the put seller was assigned the option and purchased 100 shares of SU at the strike price of $23.00. Then, in theory, the stock could fall to zero.
If the put seller gets assigned the option, the maximum risk is similar to that of stock ownership but partially offset by the premium (of $123) received.
Bottom Line
Cash-secured put selling is a moderately more conservative strategy than buying shares of a company outright at the current market price. This strategy can be a way to capitalize on the wild swings in SU stock with a measure of prudence.
Those investors who end up owning SU shares as a result of selling puts could further consider setting up covered calls to increase the potential returns on their shares. In other words, selling cash-secured puts could be regarded as the first step in stock ownership. Once the investor owns 100 shares of SU, s/he would be entitled to dividends (current yield at 2.8%) and would also be able to sell covered calls.