Marathon Oil's High FCF Yield Makes Its Covered Call and Short Put Yields Are Attractive

Oil - iStock-1174018800

Marathon Oil (MRO) reported consistent free cash flow (FCF) giving it a 16% FCF yield. It also gives MRO stock an attractive 1.8% dividend yield. Moreover, this makes covered call and short-put options plays attractive in nearby expiry periods.

On Feb 21, Marathon Oil reported that its Q4 free cash flow came in at $2,029 million for 2023. That represents 14.77% of its present $13.73 billion market capitalization today at $24.34 per share. 

This is a desirable situation for investors since Marathon Oil has said it expects to pay out at least 40% of its operating cash flow going forward. This is in the form of dividends and also share buybacks. 

As it stands, the 44-cent dividend works out to a 1.8% dividend yield. But the shareholder yield is even higher.

Forecasting Total Shareholder Yield

For example, based on its 577.2 million shares outstanding the 44 cents dividend per share (DPS) costs just $254 million annually. This is only 13.3% of the $1.9 billion in FCF it forecasts for 2024 at $75/bbl in WTI oil equivalent (and gas metrics). 

It is also just 33% of 40% of the FCF or $760 million it expects to pay out this year to shareholders (i.e., 40% x $1.9 billion).

That means there is still over $500 million it will spend on share buybacks (i.e., $760 million - $254 million = $506 million). Here is how these two actions benefit shareholders.

First, note that at today's price of $24.34 per share, $506 million would buy back 20.8 million shares (i.e., $506/$24.34). That works out to 3.6% of its 577.2 million shares outstanding.

But, to be conservative, let's assume that the average buyback price is $26.61 per share (i.e., 10% higher than today's price). That means it will buy back 19 million shares this year (i.e., $506m/$26.61 = 19.015m). This works out to 3.3% of its existing 577 million shares.

So, here is how we calculate shareholder yield: 1.8% dividend yield +3.3% buyback yield +10% stock price increase = 15.1%.

In other words, this stock looks very attractive now to value investors as a 15% relatively stable return is very high. 

However, there is one more way shareholders can make extra income: shorting out-of-the-money (OTM) calls (i.e., covered calls) and cash-secured puts (i.e., OTM short-put plays). This works best in nearby expiry periods.

Shorting Covered Calls and OTM Puts for Income

For example, look at the March 15 expiration option chain, which is less than three weeks away from today (i.e., 17 days). It shows that the $26.00 calls trade for 14 cents on the bid side. That works out to a 0.575% covered call yield (i.e., $0.14/$24.34). In addition, the strike price is 6.82% over today's spot price. 

So, even if the stock is called away the investor would make a total return of 7.4% (i.e., 6.82% +0.575% = 7.395%).

MRO calls expiring March 15 - Barchart - As of Feb. 27, 2024

But that is not it. Investors can also short out-of-the-money (OTM) put options for income as long as they secure extra cash and/or margin. For example, look at the same period puts at the $23.5 strike price. They trade for 32 cents on the bid side.

MRO puts expiring March 15 - Barchart - As of Feb. 27, 2024

That means that the investor who secures $2,350 in cash/margin can make $32 per put contract. That works out to an additional 1.36% in yield (i.e., $32/$2,350). Note that this strike price is still 3.45% below today's price of $24.34 per share.

So, the total potential return for the investor doing both a covered yield and short put play can make at least a 0.575% covered yield plus a 1.36% short put yield, or almost 2.0% (i.e., 0.1935%). Moreover, if the stock rises to the $26 covered call strike price, the total return will be 7.395% +1.36%, or 8.755%.

Downside Risk Issues

Even if the stock falls to $23.50, the investor keeps the 2.0% combined options yields. That effectively lowers the breakeven price to $23.04 (i.e., $23.50-0.14-0.32). Moreover, at that breakeven price, the dividend yield is attractive at 1.91% (i.e., $0.44/$23.04).

In addition, if the short put play is exercised the investor now owns more MRO shares. They can then do more covered call yields to help improve any unrealized capital loss. But, given the company's consistent FCF, it seems likely that MRO won't stay at that price - at least as long as oil prices stay relatively stable.

More Energy News from Barchart
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.