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PBR Call Options: Provide 250% Upside a definite opportunity

Aug 07,2014  Op-Ed  Comment: 0

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New York City, New York – (StockNewsDesk) – 08/07/2014 — One of the best trades in 2014 has been playing the Indian stock market, as it burst past its all time highs and continues to blaze higher.

The catalyst for this huge move up was the Indian elections in which a business friendly government was elected with a strong mandate to institute reforms. Investors cheered the ascension of a new ruling party and enthusiastically have bid up shares to new record highs.

Below is a 3 year, weekly chart displaying its performance:

BSE

A similar catalyst is looming in Brazil, where elections are looming in two months time. Although the outcome seems less clear in this case, it is deemed likely by seasoned observers that the opposition party, with a capitalist bent, will oust the current regime. This will provide a boost to Brazilian shares and specifically Petrobras – Brazil’s largest company which holds the world’s largest underseas oil reserves.

The current regime has become unpopular due to its mismanagement of the World Cup and the economy, one sign of this has been the riots that plagued the country in recent months. This is despite aggressively working to increase subsidies by pressuring domestic companies such as Petrobras to keep prices low and force them to increase hiring and purchase domestically. Of course, this came at the expense of Petrobras’ bottom line. Most important was the government’s decision to keep fuel prices low, therefore at some point Petrobras was losing money on each liter of gasoline sold.

Obviously, this affects Petrobras’ stock price as it has failed to meet investors’ expectations despite rising oil prices over the last few years. It was not long ago that Petrobras was one of the hottest stocks in the entire market. Here is a ten year, monthly chart of PBR:

PBR

Clearly, due to these political difficulties, PBR has not participated in the global rally in energy stocks. Most multinational oil companies that compete with PBR like Exxon and Chevron are close to or above their previous peaks.

The election of a new government is a clear catalyst that will elevate PBR to new heights as they will loosen restrictions and move to a more market based system.PBR then can conduct business operations in a manner to maximize shareholder value rather than working as an arm of the ruling political party.

Even in the increasingly rare case that incumbents win, certainly PBR’s shares would be hit in the short term, but this would also be a buying opportunity for a few reasons. One of them is it is a tradition that prior to the elections, subsidies are increased to improve the chances of the incumbent party and after the election, and prices are raised due to the less political blowback. Both of these factors would be bullish for PBR’s stocks.

Another catalyst is the rise in oil prices and increased economic growth, which looks supportive of higher oil prices. As PBR is sitting on trillions of barrels of oil in reserve, any uptick in prices materially impacts PBR’s asset value.

Another positive of this option trade is that the options are very cheap and pretty liquid. Here is PBR’s call option chain:

PBR-call-option-chain

The best risk/reward is with the October options at an 18 strike. If the incumbent party is voted out, these would easily triple in value. I would use dips to add to this position, saving some reserves for a bigger dip in case of an election surprise.

 

 

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