Chevron (NYSE:CVX) stock has seen an upward trajectory in sync with the surge in oil prices. Furthermore, strong Q3 cash flow results and a probable dividend increase are on the horizon, making it an enticing opportunity for income generation by shorting out-of-the-money put options.
As of early trading on September 29, CVX stock hovered just below the $170 mark, at $169.89. This represents an increase from the $167.10 per share it was trading at when we published our September 10, 2023, Barchart article, titled “Chevron Is Moving Higher With Oil’s Rise – CVX Stock is Still Cheap.”
Rising oil prices are set to significantly bolster Chevron’s cash flow for the quarter. In its Q2 presentation, the company provided guidance indicating that production would remain flat. However, given the rapid surge in oil prices, it wouldn’t be surprising to see Chevron exploring options to boost production.
In Q2, Chevron generated $9.4 billion in cash flow from operations (CFFO) before accounting for working capital changes, well in excess of its $2.8 billion dividend expenses and $4.4 billion in buybacks. Even if we consider these two uses of free cash flow, totaling $7.2 billion, Chevron’s CFFO still exceeds this amount. With the current quarter’s oil price surge, we can anticipate an even higher CFFO figure.
Assuming Chevron achieves $10 billion in CFFO for the quarter, this puts it on an annualized rate of $40 billion. Given its market capitalization of just $323.1 billion, this translates to an impressive CFFO yield of 12.3%, before factoring in capital expenditures and working capital cash charges. Even if these factors consume half of that amount, the stock still boasts a healthy free cash flow (FCF) yield of 6.15%, indicating its relative affordability.
To put this in perspective, at a 5.0% FCF yield, Chevron stock should command a market cap of $400 billion, still 23.8% above its current market cap. This suggests that CVX stock may be valued at around $210 per share, an increase of 23.8% from its current price of $170.
Moreover, over the past five years, Chevron’s average price-to-earnings (P/E) multiple has stood at just 12.6x, according to Morningstar, excluding the outlier year of 2020 when it reached 31x. This is 7.2% higher than its expected 2024 forward multiple of 11.75x. In other words, Chevron stock could be worth between 7% and 23.8% more than its current price, with an average price target of $196.35 per share over the next year if it aligns with historical and anticipated valuation parameters.
One strategy to consider is shorting out-of-the-money (OTM) put options to supplement your income. In a previous article, we recommended shorting the OTM puts with a $160 strike price for the October 6 expiration period, yielding an immediate return of 0.5875% and an annualized expected return of 7.05%. However, the premium for these puts has since dropped significantly.
A better approach might be to look at the October 20 option expiration period, which is 4.3% out-of-the-money with a $162.50 strike. Here, the premium is 95 cents per contract, offering a yield of 0.585% or an annualized return of 9.9% if repeated every three weeks. While this strategy requires securing $16,250 in cash or margin, the potential annual earnings could reach $1,615, equivalent to 9.9% of the at-risk amount.
Additionally, the downside risk is limited, with the worst-case scenario involving purchasing the stock at $162.50, accompanied by a dividend yield of over 3.7% before any potential dividend hike. Moreover, considering the income earned from shorting puts, the effective breakeven price stands at $161.55, providing a 4.4% cushion below the current price.
In a more conservative approach, investors can consider shorting the $160 strike price, which offers a lower yield of 0.381% but is 5.78% below the current price. On an annualized basis, this still represents a healthy return of 6.48% if repeated every three weeks.
In summary, Chevron’s stock presents an attractive opportunity with the potential for at least a 15% higher target price. One way to leverage this potential while generating extra income is to short out-of-the-money puts, offering the possibility of an additional 10% return over the next year.
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Author Faith Yakubu 
