For several years, I have been on a lonely, silent crusade to identify value, and act upon the insights of my search. The sore thumb of value investing has been energy: specifically oil, and its protracted, painful collapse. From a peak of $107 per barrel in 2008, it plunged to a low of $37 in 2016. Such a swoop is by no means unusual: prices hit $111 in 1980, and dropped to $32 in 1986. A price of $43 in 1990 was followed by 1993's $28. By now, a sane person must understand that volatility in oil prices is .. normal. But that's not the way people look at things. Each high has been accompanied by endless speculation that "this is just the start"; peak oil has arrived, and a world of endlessly expensive oil is just beginning. The troughs also bring out gloom and doom, none more emphatic than the most recent set of predictions that peak oil's opposite (obsolete oil?) is on the horizon. Shale oil drillers, along with electric automobiles, windmills, solar arrays and gigantic storage batteries, mean the end of fossil fuel, sooner rather than later. So, oil will slump into irrelevance. Stay away!
Except, it looks like the cycle is entering the next up stage. 2017's average domestic oil price has hovered around $43, up sharply from 2016. And now there's a steady drumbeat of news regarding production cuts, and potential supply shortages. The hurricanes have had an effect, but it's dwarfed by the stark fact that new production doesn't begin to compensate for drawdowns of existing supply. So, very long term, oil might still dwindle into irrelevance, but in the next ten years, that's a TERRIBLE bet.
Which brings me (surprise, surprise) back to my favorite value theme: Transocean as a proxy for oil. Yes, I know it's only one small part of a gigantic tapestry, but it occupies an important niche; one that will unquestionably participate both in the downs AND ups of the industry. I've followed the stock and (more importantly) bonds for several years now. A careful, quarter-by-quarter analysis of its financial statements has led me, repeatedly, to predict the company's ultimate survival, and concomitant recovery of its stock (and more importantly) bonds.
We appear to be at an inflection point. Most of Transocean's bonds have recovered from huge discounts to recent par and near-par results. My favorite issue, the Global Marine 7% bonds of 2027 are how trading above 100 (par). Considering that I bought significant numbers of these bonds at and below 40, the effect on my portfolio has been galvanic!
The story is still incomplete: bonds due in 2038 and 2040 still trade at a substantial discount to par (as low as 80), and sport yields above 9%. And the stock still trades below 11, near the bottom of the range is has traversed since I got on board. So, is Transocean still a value story?
I think so. With bonds ten years out trading at par, it is clear that the cautious folks who invest in them are no longer worried about the company collapsing anytime soon. Certainly, they think it will survive through 2027. They still clearly worry about the longer future. And the stock price still reflects deep worry about Transocean's immediate profitability. But notice, profitability is NOT the same thing as survival. The company will (bond-holders say) survive long enough to pay its debts through 2027; but it may not be a good investment (say the stock-holders).
Note: both groups might be right. But it's really interesting that the historically most worry-prone group is now complacent. To me, that is a good hint at where the stock is likely to go. Would I bet the farm on it? Of course not. Rather, I will still (cautiously) push the bond envelope (maybe the 7.5% notes of 2031).
And, continuing a theme I pursued awhile back, I'm also establishing paired options; long in-the-money calls with short at-the-money calls. My present positions (a variety of leaps maturing in 2018 and 2019) will ripen to a gain of $20,000 if the stock closes at or above $10 in 2018 (the first set) or 2019 (the second set). Since the stock is presently hovering above $10, this scenario looks pretty good. I also have a few un-paired long calls ($5s of 2019), and am waiting for the stock to rise enough to permit the sale of corresponding 10's or 15's). The magic point will probably be somewhere around $12. Sounds like a plan. Going forward, the story looks good.
But not compelling. Transocean can still yield generous returns, but no more home runs. Frankly, I'm a bit at (Tran)sea. The Transocean story was very clear to me a couple of years ago. It looked volatile, and yes, risky. However, the opportunity seemed to solidly outweigh the peril. So, I took actions, step-by-step, and waited for the good news to trickle in. It took a lot longer than I originally expected, but the narrative never changed.
Now I need to find a new story.
What will that be? I have absolutely no idea, just a little faith that moments like this ultimately give way to clarity (and fear, and second-guessing).
Update: April, 2018. When you have a solid investment idea and commit to it aggressively, there is usually an extended period of uncertainty. That's been the case with my recent flirtation with Transocean options. The stock has been highly volatile, rising to over 11, and sinking back to the mid-nines. I've used the drops to buy back short calls (which had dropped drastically as the stock receded) and establish new long positions. I've also been shifting the portfolio from 2019 strikes to 2020. At one point, very recently, the combined positions showed a paper loss of $14,000. However, the recent burst to the mid-11 range turned that into a net gain of $18,000. Now for reap mode! The upturn enabled me to reestablish the spreads by selling at-the-money 2019 calls. This locks in a 250% gain if the stock remains at or above $10. So, to date, I have a total profit of $42,000 in realized and paper gains. Since the cumulative investment is around $24,000, that's spectacular. When a bet works out as predicted, the feeling is absolutely ecstatic!
The scenario above has played out at least twice since I began the Transocean option experiment. Pairing options (long call in-the-money, short call at-the-money) allows for positive outcomes in both down and up markets. The short calls gain value as the stock drops (that is, you owe less); the long calls gain as the stock rises. So, you can buy back the short calls after a substantial drop, realizing a gain to cushion the long call drop. Then, when/if the stock rebounds, short calls at-the-money can be written again.
Basic to this yo-yo investing is a correct judgement as to the long-term direction of the stock. If Transocean were to begin the two-year cycle at 11 and end at 3, then the loss would be 100%. NEVER forget that fact. If it becomes clear that the initial thesis was wrong, then accepting a haircut (say 50%) would be wise, if painful. This also means that you need to be quite greedy about the upside. My rule of thumb is to try for a two-fer plus or better. So, I want to turn a net $4000 investment into $10,000. That's what my latest set of spreads will permit. This lets me be wrong twice for every success, assuming I stop the bleeding at 50% for the duds.
The game works best (theoretically) with the longest LEAPS you can find. The trouble is that the market spreads on the longest LEAPS are generally very high indeed. So, it's usually best to wait a few months after they appear before buying the in-the-money initial positions. Then you wait for your prescient judgment regarding the stock to be validated by the market. After the rise, you can then pair the long calls with short ones at-the-money. Good luck!
Update: Just a couple days later. Now the stock has jumped to $12.60, enabling me to sell another set of covering calls (2020 at 12), Again, the potential profit for the 25 paired Leaps is 250%. Selling the at-the-money calls also reduces risk sharply, as my uncovered positions are now down to 35 (from 60). The swing over just a couple of weeks has been dramatic, over $40,000 to the upside.
And yes, I am very aware it can turn on a dime! That's why I'm covering as the stock rises.
Update: October, 2019.
Where to begin? It's been absolutely horrid! RIG was at $12.60 in my last update; now it's at $4.53! And that's not even the bottom, which was $4.24! That's a stomach-churning 66% drop! So, at least up to now, I've been consistently, terribly wrong about the stock. AND, I've booked a net profit of $370,000 (income and capital gains) on the various bond and option investments! The latter have been largely a wash, with 2019 drops pretty much wiping out earlier gains, but the bonds have performed marvelously. I took advantage of a recent surge in price with the Global Marine bonds, which recent rose again to near-par, to lock in gains and reduce exposure to securities now rated in the CCC range. This is not to say that I regard the bonds as lost money. In fact, I still own a fair number of Transocean and Global Marine bonds, presently showing a profit over purchase cost. But I'm watching them like a hawk!
Overall, it's been a humbling experience. Throughout, my conviction level about RIG as a company was high, but faulty. What does shine through, though, is the resilience of my thesis regarding bonds: they may wobble all over the place, but most of them muddle through. For every Clear Channel, which ultimately died after a decade of torment, there are twenty stories of survival. And even lousy old Clear Channel, if traded judiciously, might have spun off handsome returns for the adventurous. That's not my game, but there are times when I wonder whether it should be part of the grander scheme.
The scenario above has played out at least twice since I began the Transocean option experiment. Pairing options (long call in-the-money, short call at-the-money) allows for positive outcomes in both down and up markets. The short calls gain value as the stock drops (that is, you owe less); the long calls gain as the stock rises. So, you can buy back the short calls after a substantial drop, realizing a gain to cushion the long call drop. Then, when/if the stock rebounds, short calls at-the-money can be written again.
Basic to this yo-yo investing is a correct judgement as to the long-term direction of the stock. If Transocean were to begin the two-year cycle at 11 and end at 3, then the loss would be 100%. NEVER forget that fact. If it becomes clear that the initial thesis was wrong, then accepting a haircut (say 50%) would be wise, if painful. This also means that you need to be quite greedy about the upside. My rule of thumb is to try for a two-fer plus or better. So, I want to turn a net $4000 investment into $10,000. That's what my latest set of spreads will permit. This lets me be wrong twice for every success, assuming I stop the bleeding at 50% for the duds.
The game works best (theoretically) with the longest LEAPS you can find. The trouble is that the market spreads on the longest LEAPS are generally very high indeed. So, it's usually best to wait a few months after they appear before buying the in-the-money initial positions. Then you wait for your prescient judgment regarding the stock to be validated by the market. After the rise, you can then pair the long calls with short ones at-the-money. Good luck!
Update: Just a couple days later. Now the stock has jumped to $12.60, enabling me to sell another set of covering calls (2020 at 12), Again, the potential profit for the 25 paired Leaps is 250%. Selling the at-the-money calls also reduces risk sharply, as my uncovered positions are now down to 35 (from 60). The swing over just a couple of weeks has been dramatic, over $40,000 to the upside.
And yes, I am very aware it can turn on a dime! That's why I'm covering as the stock rises.
Update: October, 2019.
Where to begin? It's been absolutely horrid! RIG was at $12.60 in my last update; now it's at $4.53! And that's not even the bottom, which was $4.24! That's a stomach-churning 66% drop! So, at least up to now, I've been consistently, terribly wrong about the stock. AND, I've booked a net profit of $370,000 (income and capital gains) on the various bond and option investments! The latter have been largely a wash, with 2019 drops pretty much wiping out earlier gains, but the bonds have performed marvelously. I took advantage of a recent surge in price with the Global Marine bonds, which recent rose again to near-par, to lock in gains and reduce exposure to securities now rated in the CCC range. This is not to say that I regard the bonds as lost money. In fact, I still own a fair number of Transocean and Global Marine bonds, presently showing a profit over purchase cost. But I'm watching them like a hawk!
Overall, it's been a humbling experience. Throughout, my conviction level about RIG as a company was high, but faulty. What does shine through, though, is the resilience of my thesis regarding bonds: they may wobble all over the place, but most of them muddle through. For every Clear Channel, which ultimately died after a decade of torment, there are twenty stories of survival. And even lousy old Clear Channel, if traded judiciously, might have spun off handsome returns for the adventurous. That's not my game, but there are times when I wonder whether it should be part of the grander scheme.
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