A Bullish Chesapeake Options Strategy

Chesapeake Energy CHK has been heavily covered by the media over the past few weeks. Most recently, Carl Icahn, famed activist shareholder, took a 7.56% stake in the name. Black Rock BLK also took an interest in the name--reportedly boosting its stake in Chesapeake to 4 million shares. In recent weeks, shares of Chesapeake have sold off, mostly on the fear that the company's management may have taken on too much debt. To combat this, Chesapeake has been selling assets to raise cash. Moreover, Chesapeake is facing corporate-governance controversies involving its CEO. Aubrey McClendon, Chesapeake's CEO, has had an agreement with the company to take a partial ownership stake in some of the company's wells. If one believes that a new board and the company's management can turn around Chesapeake, there is a lot of upside considering Chesapeake is currently trading below book value and 8x forward earnings. Obviously, Chesapeake is also an indirect play on natural gas. Natural gas is currently trading near its all time low. A turnaround in the natural gas market may increase Chesapeake's bottom line depending on the company's commodity hedging structure. When trading Chesapeake, employing an options strategy may be best because of the risk associated with the name. Selling a bull put spread with October expiration gives time for the stock to recover. Selling a put with a strike price of 10 expiring in Oct for $0.97 and buying a put with a strike price of 9 expiring in Oct for $0.81 would give a net credit of $0.17. This strategy has the potential to return 17% on investment in 140 days and it provides over 33% downside protection. If the put spread is held till expiration, maximum profit from this strategy occurs if Chesapeake closes above $10 a share. Maximum loss, which is 100% of the initial investment, occurs if Chesapeake closes below $9 a share at expiration. The risks to the strategy include deterioration of already poor fundamentals, continued downward price momentum, and a break of the $10 a share support level.