ExxonMobil Covered Call Could Protect Gains Prior To Q1 Results

The fortunes of oil supermajors like Exxon are typically linked to the price of crude oil. In July 2014, the stock was just shy of $105, a record high. Since then, the shares have been in decline. In fact, in the early days of the pandemic in 2020, shares were trading around $30.

Crude oil comes in different grades. Two different prices usually get the most attention, namely the global benchmark Brent crude and the U.S. benchmark West Texas Intermediate (WTI). In early 2020, both were above $60 per barrel. By March of that year, they had dropped to $20.

The global pandemic adversely impacted near-term demand for oil, leading to an oversupplied market which weighed on prices. As a result, ExxonMobil’s sales and operating revenues were hit hard. But costs remained relatively high, adversely affecting corporate margins. And XOM stock initially reflected the uncertainty in the markets. But since then the shares have gained back their value.

Therefore, today, we look at ExxonMobil, which is expected to release Q1 earnings on Apr. 30, and provide the example of a covered call. Given the recent run-up in price, many investors would be keen to protect their gains, especially during the typically volatile earnings season.

Over the past several weeks, we have discussed how investors could consider writing covered calls on their stock holding. Such an option strategy could help decrease the volatility of their position and offer shareholders some protection against declines in the share price. Readers who are new to options might want to revisit the initial article in the series before reading this post.

Intraday Price: $55.50
52-Week Range: $31.11-$62.55
Year-To-Date Price Change: Up about 34%

Texas-based ExxonMobil is one of the world's largest refiners with a total global refining capacity of 4.8 million barrels a day. It is also a leading manufacturer of commodity and specialty chemicals.

ExxonMobil announced Q4 and full-year 2020 results at the beginning of February. During the last quarter of 2020, the company’s top line declined by 31% YoY to $46.5 billion. Net loss was $20.1 billion, making it the fourth-straight quarter of losses.

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CEO Darren W. Woods stated:

“The past year presented the most challenging market conditions ExxonMobil has ever experienced.”

The company expects 2021 cash flow to cover capital expenditures while maintaining the dividend. These expectations are valid at Brent prices of $50 per barrel.

ExxonMobil stock’s forward P/E and P/S ratios are 17.95 and 1.33, respectively. Given the rapid increase in XOM's stock price in the past several months, a covered call before the earnings release might be an appropriate strategy for some investors.

For every 100 shares held, the strategy requires the trader to sell one call option with an expiration date at some time in the future.

On Tuesday, XOM stock hovered at $55.6. Therefore, for this post, we’ll use that price.

A stock option contract on XOM (or any other stock) is the option to buy (or sell) 100 shares.

Investors who believe there could be short-term profit-taking soon might use a slightly in-the-money (ITM) covered call. A call option is ITM if the market price (here $55.6) is above the strike price ($52.50).

So the investor would buy (or already own) 100 shares of XOM stock at $55.6 and, at the same time, sell an XOM May 21, 2021, 52.50-strike call option. This option is currently offered at a price (or premium) of $3.95.

An option buyer would have to pay $3.95 X 100, or $395, in premium to the option seller. This call option will stop trading on Friday, May 21, 2021.

The premium amount belongs to the option writer (seller) no matter what happens in the future.

The 52.50-strike offers more downside protection than an at-the-money (ATM) or out-of-money (OTM) call.

Assuming a trader would now enter this covered call trade at $55.6 at expiration, the maximum return would be $85, i.e.: ($395 – ($55.6 - $52.50) X 100), excluding trading commissions and costs.

An ITM covered call’s maximum profit is equal to the extrinsic value of the short call option.

The intrinsic value would be the tangible value of the option if it were exercised now. This, our XOM call option’s intrinsic value is ($55.6 - $52.5) X 100, or $310.

The extrinsic value is the difference between the market price of an option (or the premium) and its intrinsic price. In this case, the extrinsic value would be $85, i.e. ($395 - $310). Extrinsic value is also known as time value. The trader realizes this gain of $85 as long as the price of XOM stock at expiration remains above the call option's strike price (i.e.: $52.50).

On expiration day, if the stock closes below the strike price, the option would not get exercised, but would instead expire worthless. Then, the stock owner with the covered call position gets to keep the stock and the money (premium) s/he paid for selling the option.

At expiration, this trade would break even at an XOM stock price of $51.65 (i.e.: $55.6 - $3.95). excluding trading commissions and costs.

Another way to think of this break-even price is to subtract the call option premium ($3.95) from the underlying XOM stock price when we initiated the covered call (i.e.: $55.60).

On May 21, if XOM stock closes below $51.65, the trade would start losing money within this covered call setup. Therefore, by selling the covered call, the investor has some protection against a potential loss in the case of a decline in the underlying shares. In theory, a stock’s price could drop to $0.

As we have noted in earlier articles, such a covered call would limit the upside profit potential. The risk of not participating in XOM stock’s potential appreciation fully would not appeal to everyone. However, depending on their risk/return profiles, others might find that acceptable in exchange for the premium received.

For example, if XOM stock were to reach a new high for 2021 and close at $70 on May 21, the trader’s maximum return would still be $85. In such a case, the option would be deep ITM and would likely be exercised. There might also be brokerage fees if the stock is called away.

As part of the exit strategy, the trader might also consider rolling this deep ITM call option. In that case, the trader would buy back the $52.50 call before expiry on May 21.

Depending on her/his views and objectives regarding the underlying XOM stock, s/he could consider initiating another covered call position. In other words, the trader could possibly roll out to a June 18 expiry call with an appropriate strike.

Finally, we should remind readers that ExxonMobil stock goes ex-dividend on May 12, a date that matters to covered call writers. An investor has to own XOM shares by close of market on May 11 in order to receive this dividend.

As the writer of the XOM covered call, the trader might become subject to an early exercise since the buyer of the option might want to capture this dividend.

Such an early exercise usually takes place on the day before the ex-dividend date and, in the case of ITM options, which do not have much time value. Call writers need to be cognizant of the ex-dividend date as the covered call strategy might require managing.

Bottom Line

The exact market timing of when XOM shares could take a breather is difficult to determine, even for professional traders. But options strategies provide tools that might prepare for sideways moves or even drops in price, especially around the earnings release date.

We regard covered call options as a potential way to earn additional income from your stock portfolio. Such a strategy also helps lower portfolio volatility. Interested investors might consider increasing their knowledge base.

Written By: Investing.com