Not the typical puts/calls DD but thought some here might like a different approach to gambling in the market. You probably can’t do this on robinhood.
Rationale: CHK is in a world of trouble and likely to file for bankruptcy this year. They were a pioneer in the natural gas space but have been bleeding out with the long term secular decline in natural gas prices. Revolver usage is uncertain and they are now exploring bankruptcy. Bond maturities in August and November will likely trigger default unless they file before then.
Position Overview – getting the calls on at a decent price is the hardest part so I started there and built the rest of the position around the calls as I was able to get them:
(1) Short $CHK – $11.05 short $11k or 1000 shares
(2) Buy protective CHK calls – Jan calls mid at 11 strike ~$4 so $4,000 to cover the 1000 shares
(3) Buy CHK debt maturing in 2020 (August or Nov expiration) – $1500 for 10000 par at 15/100
(4) Consider buying some preferred (say $100) at $2 par $100 – $200
If CHK files before your bonds mature, the stock will be worthless given CHK’s debt load, so your short makes:
~11k from stock short
less borrowing costs of roughly $2.5k depending on when they file
hedges of $4k
So $3500-$4500, and your bonds will likely still have some value in bankruptcy and you end up owning a piece of whatever newco is
If CHK recovers, the stock will explode in value, so you:
Are covered on the CHK rise but lose $4k in hedge cost
Make ~$8.5k from your bonds
Less borrowing costs of roughly $2.5k, but borrowing cost likely to go down if they were to recover
Value of prefs should increase materially, hard to say what ultimate value would be
So $2,500 + your prefs just rose in value – hard to say what ultimate payoff would look like – if there is a takeout your prefs payout for $10,000. You could also roll everything at this point into next expiring bonds etc. depending on what CHK’s outlook is.
Risks/Beware: Your broker is likely to give you horrible marks on this so it CANNOT BE A LARGE % OF YOUR ACCOUNT SIZE. Borrow is around 70% now and it may be hard for you to find shares to short depending on your broker. You can create the position synthetically with puts and calls but that comes with a whole different set of risks. You also may have a hard time buying everything with one broker depending on your account size etc.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.