Dykstra: Unit Corp. Is Another Solid Oil Play

This firm is ripe for an options play. Also, reader feedback.
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Earlier in the week,

I wrote

about the technical and fundamental strength at

EOG Resources

(EOG) - Get Report

. The reasons to buy EOG are common among all of the stronger companies in the oil and drilling sector.

With that in mind, today I would like to take a look at

Unit Corp.

(UNT) - Get Report

.

Unit explores for and drills oil and natural gas from its properties in Texas and Oklahoma, and also provides contract-drilling services.

Since peaking out in June, the stock has declined steadily, leveling off in recent weeks. A fire at a Valero refinery made a large dent in Unit's second-quarter earnings, but such events provide buying opportunities once the company recovers and begins full operation again.

With negative sentiment built into the stock price, we only need a quick change for deep-in-the-money (DITM) options to work for us. Taking a look at the company's fundamentals highlights the strength of this stock. With a forward price-to-earnings ratio under 7 and a return on equity of over 25%, the company has the assets and resources that will help generate steady profits.

Knowing the underlying strength in the stock, I will place a limit order to buy 10 contracts of the March $35s (UNTCG) for $14.40 or better. The stock was recently trading at $48.44.

Now, as we do every Friday, let's take a look at your emails.

I've started reading your column fairlyrecently and have gone back to read mostof the previous columns available on theWeb site. I like your strategy, but I amstill uncertain how you arrive at theoptimal strike price and your entry andexit prices. The strike and buy pricesI can just pull out of your column ifI'm lazy, but to place the GTC sellorders, I need to know how to price theexit. Any insight you could providewould be greatly appreciated.-- Rob

Rob,

Thank you for your interest in my DITM calls strategy. When calculating an entry point, the first step is to look for the "calls" coptions; then, go about four to seven months out in time. Most of the time, the strike price that is selected will have a premium that will cost us about one dollar more than the current stock price.

My exit price is much easier to calculate, as I set my good-till-canceled (GTC) sell limit order at 1 point higher than the average cost basis of my open calls. The reason I choose a profit of $1,000 per trade is simple: One

must

take a profit when available, period! Trying to "catch the top" is a fool's game. The benefit of the GTC order is that it gives one the freedom of collecting profits, without having to watch the stock ticker all day.

It seems to me a "doomsday scenario"for your strategy might occur if thestock market went down quickly and stayed down for many months.Have you ever quantified this risk?For example, how many Dow points or S&P points would the market have toshed for how long a period of time foryour positions to be seriously hurt?What is the likelihood that such ascenario might occur?Thank you for your work,column and explanations. You're thebest.-- David

David,

The thought of a "doomsday scenario" you described is nearly impossible. Here is why: If every stock underlying all my open positions were to go to zero tomorrow and be worthless,

my focus would change from investing to surviving just like everyone else

, as something unexpected and unfathomable would have to occur to cause such a scenario.

I noticed that when you purchasecontracts in excess of your initial 10contracts on any given call option,your GTC sell price drops from $1.00 to50 cents. What is your rationale forthis, given your "conviction" for theunderlying stock's ability to advance?Thanks.-- Gary

Gary,

Your conclusion is understandable but not accurate. The "time factor" leads me to adjust my GTC sell price, not the quantity of contracts purchased. The reason I adjust my GTC sell price is time decay.

As the option stays open for several months, my return on investment falls. My DITM calls strategy is most effective when I can turn a trade as quickly as possible. Therefore, I will adjust my GTC sell price to exit a trade quicker, so we can choose a new stock (DITM call) for better use of the capital.

A million thanks for such a thoughtfulcolumn and for your efforts to educate andmotivate the small investor. We need it.

Just wanted to know ... can one trade DITM throughonline brokers? Or can I play along bybuying the stock outright (it's pricier I know).

You have been/continue to be an inspiration to somany of us. You efforts are greatly appreciated;

JRamirez

If you want to follow my DITM calls strategy using an online broker, you can, but you will have to switch to an online broker that specializes in options -- there are many out there. As this is a forum for the readers, perhaps the readers would like to respond and tell me which online broker they like the best for trading options. Then, next week, I'll post the results.

At the time of publication, Dykstra had no positions in stock mentioned.

Nicknamed 'Nails' for his tough style of play, Lenny is a former Major League Baseball player for the 1986 World Champions, New York Mets and the 1993 National League Champions, Philadelphia Phillies. A three time All-Star as a ballplayer, Lenny now serves as president for several privately held businesses in Southern California. He is the founder of The Players Club; it has been his desire to give back to the sport that gave him early successes in life by teaching athletes how to invest and protect their incomes. He currently manages his own portfolio and writes an investment strategy column for TheStreet.com, and is featured regularly on CNBC and other cable news shows. Lenny was selected as OverTime Magazine's 2006-2007 "Entrepreneur of the Year."