They do not operate in the most innovative industry: in the Oil Business the technology is not changing much, the cost of production is stable, the price in the market is stable and the demand from the consumers is stable. So nothing changes ! And the stock price of this company has shown no development at all, it stayed completely flat over the past 12months: the $XOM stock actually moved down 2.16% while the S&P500 gained 17%...
So now comes the trick! The first thing is that you should own the stock. You should actually own 100 shares of EXXON or a multiple of 100 since the options of EXXON are traded by packs of rights to buy/sell 100 shares. So let us assume you have 100 shares of EXXON, which is worth $8,798.00.
Then you can boost your returns on this invested capital of $8,798.00 in EXXON by doing the following: selling a straddle on EXXON. A straddle is the combination PUT+CALL around the stock price. For instance:
- a 85 PUT with maturity in October
- and a 90 CALL with maturity in October
$123 option premium / $8,798 invested in stock = roughly 1.4%
What will happen when the Options expire, in exactly 5 weeks from now on the 3rd Friday of October?
- The most likely scenario is that the stock price remains in the range $85-$90 since it stayed like that during the past year. If the stock stays in this range $85-$90, the options will expire worthless, so the people that you sold the options to will not claim any right on those options and you will keep your 1.4% . That means that you pocket in 1.4% for 5 weeks.... which means that with selling the options gives you an annualized rate of return of 14% on EXXON ! So we would recommend you to repeat the operation and straight away resell a new straddle on EXXON directly after the expiration of the first one straddle (this time you will sell November straddles, then December straddle, then January...)
- If the stock price falls below $85, this is highly unlikely since it did not occur during one year, but who knows? Then the holder of the PUT option will oblige you to buy the stock at $85. Which is actually good for you because you are buying a stable company with a rock-solid future taking advantage of a periodic downturn in the stock price.
- If the stock price goes above $90, this also highly unlikely since it did not occur during one year, but who knows? Then the holder of the CALL option will oblige you to sell the stock at $90, or $2.02 more per share than the current stock price, your total gains are then
This is a total profit of $323 on your invested capital of $8,798. This is roughly 3.6% in just 5 weeks (36% annualized rate!)
So do you understand ? The worst thing that can occur is that you have to buy in from this stock in one month time if the stock price suddenly goes down, which actually is great for you since you can be pretty sure of 2 things: Oil is something that people will keep on buying and EXXON will remain a dominant player in this game for quite a while.