Devon Energy had earnings last week and the results were less than stellar. The stock tanked and dropped 19% in just one week.
In this post we will discuss:
Why Devon missed earnings
What is the outlook for Devon Energy moving forward?
Why now is the right time to SELL a PUT Vertical in Devon Energy
And we will show you exactly how to place that PUT Vertical Option Trade and capitalize on this opportunity with Devon Energy.
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DISCLAIMER, I am not a financial planner and I am not recommending trades. Please do your own research and if you are new or learning options, I recommend you start small.
Devon Energy (DVN) reported 4th Quarter earnings of $1.66 per share on revenue of $4.3 billion. The consensus earnings estimate was $1.75 per share on revenue of $4.6 billion.
What was the Reason Devon Missed Earnings and the Stock Tanked?
Well, there are a few reasons.
Devon Lowered Its Dividend Payout
For the second quarter in a row, the oil producer‘s total dividend outlay was lower than the prior payment.
While Devon’s cash flow was higher year over year, it declined compared to the last two quarters:
| QUARTER | OPERATING CASH FLOW | FREE CASH FLOW |
| First | $1.8 billion | $1.3 billion |
| Second | $2.7 billion | $2.1 billion |
| Third | $2.1 billion | $1.4 billion |
| Fourth | $1.9 billion | $1.1 billion |
DATA SOURCE: DEVON ENERGY.
Devon’s dividend payout is directly correlated to its cash flow. Devon pays a fixed base dividend that it can sustain at lower oil prices. In addition, it pays a variable dividend of up to 50% of its quarterly free cash flow.
With free cash flow falling because of lower realized prices, Devon’s variable dividend fell. That policy gives investors a firm income floor from the base dividend, with the potential for a high ceiling because of the variable component. This is actually a good thing.
Devon has been steadily raising that floor as it grows production and reduces costs. However, the variable payout will continue to rise and fall with its cash flow.
Devon Energy’s variable dividend policy allows investors to capitalize on higher oil prices. However, that upside also has drawbacks since the payout will fall alongside oil prices.
Supply, Demand and Inventory Levels
Devon is one of the energy companies that is very sensitive to oil supply and demand.
Oil investors recently got inventory estimates that came in higher than expected. Higher-than-expected inventories could point to weaker demand than expected. Therefore, the price of oil fell on the news.
General Economy
Oil prices didn’t get any more help, when the Producer Price Index (PPI) came in much higher than expected. That report combined with the higher-than-expected Consumer Price Index (CPI) data renewed fears the Federal Reserve would hike interest rates higher and for a longer period of time.
Higher interest rates tend to raise the value of the dollar versus other currencies, and because oil is priced in dollars, higher rates tend to depress oil prices. In addition, hotter inflation might be fueling fears of a “harder” landing or recession down the line, which has the potential to lower demand.
Lower Oil Prices
The recent dip in oil prices does not help Devon Energy. However, do you really think that the move to cleaner energy is here now and oil prices will continue to decline?
Check out the video we did last week on the trade in Crude Oil prices going forward until at least the next election. I’ll put a link down below. It covers why oil prices will likely remain high and the world’s need for oil and gas is here to stay for quite a while and is not going away anytime soon.
What is the Outlook for Devon Energy Moving Forward?
Although Devon missed on the expected top and bottom line numbers, overall, the oil company posted solid results. Oil output hit a record high while operating cash flow was up 18% year over year.
Many people, including myself, now believe Devon is undervalued at a 5.85 PE Ratio for a stock that has such solid fundamentals. It would be difficult for it to drop any further at this point and after a 19% price drop we could be in for a quick stock price rebound on any jump in oil prices.
Devon is going to continue to do very well in the current environment going forward. So let’s look at getting long Devon Energy using stock options.
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What is the Best Option Trade in Devon Energy Right Now?
Let’s go to the TastyWorks trade platform. It’s the best platform for trading options (I’ll put a link below).
We punch in DVN in the upper left and make sure we hit the Trade tab in order to see the option chains.
We want to pick the expiration date in the option chain that is closest to 45 DTE Days to Expiration.
We are right in the middle, so in this case we are going to pick the April chain to give us a little more time to be right and collect more premium upfront as well.
We look to trade SELL the nearest OTM Out Of The Money PUT option and BUY the next further OTM Out Of The Money PUT option.
However, in the case of Devon, with the recent huge drop we are going to go slightly in the money.
So, we click the BID priced at 4.50 to SELL the 55 Strike option and the ASK priced at .91 to SELL the 45 Strike.
Overall we are collecting $370 upfront by selling this PUT Vertical in Devon.
Let’s switch to the curve mode by hitting Curve in the trade tab since it is a little more visual and you can see the profit zone in green.
Again, we see that the amount we collect in credit for this trade is 3.70 or $370 since there are 100 shares. So this amount is placed in our account the minute we hit Review and Send and place the trade.
From here we hit review and send to place the VERTICAL SPREAD trade.
Now let’s take a closer look at some of the parameters and exactly what we are doing.
Setup:
– Sell OTM Put (closer to ATM)
– Buy OTM Put (further away from ATM)
Directional Assumption: Bullish
We sell a PUT Vertical Spread when we are bullish and believe the stock price will increase.
Ideal Implied Volatility Environment: High
We like to Sell Verticals when IV is high to collect more premium.
Max Profit: Credit received from opening trade
So in this case it is the $370.
BP Effect = Max Loss
The Buying Power Effect is the amount of capital that is required to place the trade. Or in other words, it is how much capital the trade is utilizing. This is also the maximum amount that we can lose since this is a defined risk trade.
BP Effect = Width of the Spread – Premium Collected
BPR = 10.00 – 3.70 = 6.30
The Vertical Spread is a cost-efficient way of investing. In this trade, we are using $630 and collecting $370. That is a 41% ROC or Return On Capital in 61 days if the option remains out of the money and worthless at expiration. Or a 284% annualized rate of return.
So as long as the stock stays above the 55 Short PUT strike price we keep the max profit.
The Breakeven
Breakeven = 55 Short Strike – Net Debit Received
So, it is 55 – 3.70 = $51.30
We don’t start losing money until the stock moves down to this point. So, if it stays where it is at or even moves down some we still profit.
Key Takeaways
The PUT Vertical option trade is a cost-efficient way of investing. We are able to collect a good premium on the upside while limiting our downside risk.
Now is a great time to consider SELLING a PUT Vertical in Devon Energy!
Alright guys, here is a link for the FREE Options Workshop. Be sure to grab that. It discusses exactly how to profit month after month utilizing option trades like this one.