Closed my CHK put option position

Here’s what I think about Chesapeake…

  1. As explained previously, their accounting and reserve estimation are very aggressive and more aggressive than most of its peers.
  2. Aubrey McClendon, the former CEO, was very good at selling and financial engineering.  The royalty trust and the midstream deal were very good deals for Chesapeake.  There is some hidden value in Chesapeake’s drilling carries (though this may be factored into Chesapeake’s PV-10 values already).  The Volumetric Production Payments and the preferred share deals are kind of smart because they transfer collateral away from Chesapeake’s bondholders.  This lowers the interest rate on the VPP and preferred shares (though Chesapeake will need to pay higher interest on any future bond issues).
  3. I was hoping that McClendon was using financial engineering to inflate Chesapeake’s books.  Largely I don’t think that he did so.  (If he did that, I’d probably be buying more puts.)
  4. The new CEO, Doug Lawler, is weird.  He legitimately cut a lot of corporate excess.  He is getting Chesapeake out of the real estate development business.  Most people would tell investors about what they have done but Lawler has not.  It’s like he wants to live in a fantasy land where he doesn’t want to admit that Chesapeake has problems like any other business???  I don’t get it.

Overall, I am still a little bearish on Chesapeake.  I may have closed my position too early.  But I don’t think that it’s a mistake to take profits given that Chesapeake is not completely awful.  It is not the worst E&P out there (look at the ones with higher short interest than CHK).

*Disclosure:  No position in CHK.

5 thoughts on “Closed my CHK put option position

  1. I know you dislike arb trades, but you could be long some CHK preferred convertible and long puts (or short CHK stock). I think there is value in CHK so I am just outright long the preferred.

    CHK-PD is the first one listed. I prefer CHKDG (2nd on the list) but it is OTC because of the higher div and lower conversion price. At times in 2013, CHKDG was trading at a lower price of CHK-PD (but not currently).

    • Ok I’m trying to understand the preferred. They look like they are slightly favorable to Chesapeake. (I continue to be impressed by Chesapeake’s financial engineering.)

      The mandatory conversion is at Chesapeake’s option. This is kind of like a bond with a call option. The company’s call option is not entirely good for the bondholders. If Chesapeake shares are overpriced, Chesapeake will convert the preferred shares into equity. This is smart because they get to do a backdoor equity raise without paying underwriting fees.

      2- The preferred I’d rather own is the CHK Utica preferred. You get 7%, plus a 3% royalty on production (*effective interest rate is not 7%+3%), plus its collateralized with the Utica assets and the drilling carry, and you are protected by a minimum drilling commitment.

      I’m not sure how bankruptcy would work but the CHK Utica preferred may have a much higher recovery than the other preferred.

  2. Mandatory conversion is only when CHK shares trade at 130% of the conversion price for 20 trading days. This was also protected by a date (that passed in 2010). CHK cannot just go ahead and convert the preferred now at its pleasure.

    What is the CHK Utica preferred. I am not familiar with that stock. What is the ticker?

    • It’s not publicly traded. The 10-K has some details about them. (Sorry if that wasn’t clear.)

      The publicly traded preferred become convertible after particular dates according to the PDF you linked to earlier.

  3. My main point is that you could use the income generated from a CHK preferred to buy puts and/or pay the borrow fee when shorting CHK stock. CHK preferred are now convertible (since the date in 2010 has passed) but an investor would not to convert until it is above the the conversion price.

    At the same time, CHK cannot force conversion until CHK trades 30% above the conversion price for 20 straight days. If you are concerned about forced conversion if this occurs in the future, it would be very easy to sell the preferred shares in advance of the forced conversion.

    I am outright long the preferred (and have no position short) as I am not worried about CHK going bankrupt like you are. I am unsure what the value of CHK is long term (but I think it is higher) and the preferred convertible gives downside protection while also giving optionality for further upside if CHK appreciates.

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