Rebounding Energy Stock Could Throw Off a 40% Annual Yield

Shares of independent oil and gas company Penn Virginia Corporation (NYSE: PVA) have been on a roller-coaster ride over the past few weeks. 

Volatility really picked up on July 31, following the company’s second-quarter earnings results. PVA announced production volume for its key Eagle Ford energy project increased 6% to 15,618 barrels of oil equivalent per day (BOEPD), but this fell short of analysts’ expectations. 

Investors were concerned not only with the lower-than-expected production for the quarter, but also with guidance for the third quarter, which management said should grow only modestly. Shares dropped more than 11% on the news, despite the fact that PVA said it expected production to ramp up in the fourth quarter.

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The tables were turned Friday, as shares took off on takeover chatter, gaining 6.5%. And the rally continued this week as Penn Virginia updated its guidance for 2014 and 2015, and Stifel Nicolaus came out saying it sees more upside in PVA on a standalone basis.

The big takeaway from the updated guidance was that while the company has struggled with near-term production schedules, the value of its Eagle Ford shale holdings remains intact. PVA said it expects a significant jump in production in the fourth quarter, which should continue into 2015. The company also said it is adding a seventh and eighth drilling rig next year, which should help accelerate production increases.

Shares have now recouped the entire loss from late July, but they are still well off their 52-week highs. PVA looks attractive at current levels, with analysts expecting earnings of $0.44 per share next year, and the long-term growth prospects of its energy assets.

PVA Stock Chart

While the company doesn’t pay a dividend,  PVA is another example of how we can use volatility and uncertainty in the market to generate attractive levels of income in our investment portfolios.

The decline in the stock has done two things for us. First, the lower price allows us to set up a put selling trade with a lower strike price, decreasing our risk. Since PVA has already priced in recent disappointments, there is a lesser probability that the stock will fall again on a bearish announcement.

Secondly, the added volatility has helped push up option premiums. This gives us an opportunity to capture more income by selling puts at a higher price point.

Today, I want to sell the PVA Oct 14 Puts for about $0.75 per share. The bid/ask spread is a bit wide, so use a limit order to enter this trade to ensure an attractive level of income.

By selling these puts, we are accepting an obligation to buy 100 shares of PVA per contract at the $14 strike price if the stock is trading below this level when the puts expire on Oct. 18. Since we are receiving $0.75 per share ($75 per contract), our net cost will be reduced to $13.25 per share. This is 10% below the current price and a very attractive entry point.

Once we sell these put option contracts, there are essentially two ways the trade can work out. Either PVA will close above $14 when the options expire, allowing us to keep the income free and clear, or it will close below $14 and we will buy the stock at a net cost of $13.25 per share.

Since there is a chance that we will be required to buy shares of PVA, we need to set aside $1,325 per contract of our own capital, along with the $75 we receive from selling the puts, as collateral. If PVA is above $14 at expiration and the contracts expire worthless, our $75 in income will represent a 5.7% gain over the $1,325 that we allocated to this trade. Since we will generate that in 52 days, our per-year rate of return nets out to 40%.

In the event that PVA pulls back from here and we are assigned shares, this would not be a bad thing, as PVA is currently in a transition period. As the company proves to investors that it is able to capitalize on its Eagle Ford properties and bring production up to a lucrative rate, the stock price should appreciate. 

I wouldn’t be surprised to see PVA trade back into the high-teens or even low $20s over the next few months. In the meantime, another attractive income opportunity for us would be to “rent” our shares to other investors — much the same as a property owner might rent an investment home to a tenant.

If you’re unfamiliar with the process of renting stocks, you should definitely take a look at this strategy. By renting shares out, investors are able to capture reliable income on a monthly basis while waiting to sell their stock at a higher price. And not only do you create additional income, but you reduce the amount of risk you take on from your stock positions. 

This is a strategy I used extensively when I managed investments for high net worth individuals, and it can be used in just about any brokerage account, including IRAs and other retirement accounts. To learn more about this lucrative income strategy, just follow this link.