Encana Covered Call converted to collar

Natural gas has dropped a lot over the last 2 years and seems to show signs of bottoming over the last few weeks. 

There is still abundant supply and a glut in the market but it will not continue that way forever. There will be new applications. Oil and coal price has gone up and the cold winter also contributed to the stabilization of price of Natural Gas.

The price may be at historic lows today but we can sure it will rise again at some point.

The way to start watching a bear market is when it gets from bad to less bad.

The simple fact today is natural gas it is the cheapest source of CLEAN energy in North America today. Eventually, the utility of natural gas and its low cost will create demand. If the price of natural gas heads up from $4 to $6 or $8 in the coming years, these assets will skyrocket in value.

Thus I am investing in one of my favourite stock, Encana, Symbol: ECA.  

Background

Encana has a market cap of about $23billion. According to SEC filings, it has 19.5 trillion cubic feet of natural gas reserves.

Encana has 23,100 producing wells. It also has an inventory of 35,000 drilling locations.That's enough inventory to drill 1,500 wells a year for more than 20 years... without doing any exploration at all.

Below is a comparison of Encana verses its peers

  

Company       Market Cap     Price to Book     Price to Cash flow     PE

Encana          $23b               1.24                     7.44                               13

Tailsman       $23b                2.04                    6.47                             34.3

Husky            $23b               1.55                     9.31                            18.8

Chesapeake $17.3             1.57                    3.22                             19.2

The key risk is the price of Natural Gas. It could go down further. The assumption is that the bottom is near.

During the worst period, Encana fell to a low of $19.21 – roughly 38% lower than today’s price. Even then, it reported a $1.9 B profit. The company paid 86¢ per share in 2009 and 2010 – two terrible years for natural gas producers. The company's production fell, its cash flow fell, and its earnings fell. But management remained conservative through the good years. It was prepared to pay its dividends even in the worst of times.

In 2010, the company bought 2% of its shares at an average price of $32.42 per share.

This is a safe and solid company.

Trades

I bought a covered call on January 12^th 2011.

All the buy signals were triggered.

BTO 1000 shares    $ 29

STO Feb 30 SC       $2.1

Cost Basis = 26.9

The stock went straight up after that and my SC went ITM

The company is scheduled to report earnings on 2/11

So I made the following adjustments:

1.     Added a short term protection put on Jan 27th BTO Feb 33 P   1.25. New CB = 28.4

2.     In order not be called out if there are good earnings, I rolled the Feb 30 SC to March 35 SC

The put is supposed to carried me through earnings.

If result is good, I can convert it to a bull put or just sell the put.

If negative results, I will roll the put to a longer period near expiration and roll the SC down and in – taking some profit from the current SC.

It is my intention to hold on to this stock longer term. My target is a >50% gain this year.

Currently, short term trend is down. The stock is overbought. Company is releasing earnings on Feb 10^th.  

For a new trade, a married put is a good idea. After earnings, if the results is good, take out the put and convert the stock into a covered call. If the market reaction is negative, add a NTM SC and roll out the put to give additional protection when it is near expiration.