A Stock With Some Bite

November 14, 2022

Oil and gas producer Diamondback Energy (FANG) – which may have the best ticker symbol in finance – reported earnings on Monday that beat analyst expectations on both the top and bottom lines. Higher oil prices led to huge jumps in net income (+82%) and revenue (28%) compared to a year earlier. For the record, the average price of oil jumped 32% from last year’s third quarter.

Analysts were bullish on the results, reacting with several price target increases. The average price target now stands 9.6% above Friday’s close, which seems reasonable for an energy stock.

FANG had traded mostly flat in 2022 … until late September. That’s when the stock went on a major rally that has covered 48% in just seven weeks. In fact, a late-week surge allowed the stock to post all-time intraday and closing highs on Friday. The stock has been riding above the support of its 20-day moving average since closing above this trendline in early October.

This trade is based on FANG continuing its rally or at least not pulling back below the 20-day (blue line), which will cross above the short strike of our put spread (red line) within the next couple of days. Note that FANG’s strike prices are unusual (155.35 and 152.7), though that should have no impact on the trade or profit potential.

If you agree that FANG will continue to respect the 20-day moving average, consider the following trade that relies on the stock staying above $155.35 through expiration in five weeks:

Buy to Open the FANG 16 Dec 152.7 put (FANG221216P152.7)
Sell to Open the FANG 16 Dec 155.35 put (FANG221216P155.35) for a credit of $0.75 (selling a vertical)

This credit is $0.05 less than the mid-point price of the spread at Friday’s $164.35 close. Unless FANG surges quickly, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $73.70. This trade reduces your buying power by $265, making your net investment $191.30 per spread ($265 – $73.70). If FANG closes above $155.35 on Dec. 16, both options will expire worthless and your return on the spread would be 38% ($73.70/$191.30).