From a top-down view of hydrocarbon exploration and production specialist Kosmos Energy (NYSE:KOS), the narrative doesn’t appear enticing. Shares slipped by double-digit percentage points in the past 52 weeks. Further, fundamental factors – such as the present impotence of oil production cuts – have not favored the upstream energy enterprise. Nevertheless, I am bullish on KOS stock because the bears are egging on optimistic contrarians, and they could very well bite.
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Wall Street Bookies Bear Down on KOS Stock
Right off the bat, we need to talk about unusual options activity for KOS stock. This recently integrated feature at TipRanks shows – as the name suggests – aberrant activity in the derivatives market compared to historical norms. It doesn’t guarantee an outcome, but it does show where the smart money may be stacked.
A sports analogy may be helpful. In an (American) football game, when the team on offense lines up in a shotgun formation – that is, with the quarterback positioned a few yards behind the center – it doesn’t guarantee that a pass is coming. However, because it’s difficult to hide the ball in such a formation, a pass represents the usual outcome.
On January 11, TipRanks reported transactions amounting to 4,004 contracts for the KOS Feb 16 ’24 7.00 call. Further, options flow data – which screens exclusively for big block transactions – notes that 4,000 of these contracts materialized on a single trade. That strongly implies that an institutional trader placed this order. As well, the data suggests that the trader sold (or wrote) these calls.
Let’s back up for a moment. In the world of sports betting, not many people take the lopsided wager that the underdog will beat the perennial favorite. It’s just not going to happen because the wager is so stacked against the underdog. So, what does the oddsmaker or bookie do? This entity sets the line or spread.
Maybe there’s zero chance that an underdog will beat the favorite straight up. However, will the favorite win by four touchdowns (28 points assuming successful conversion of the point-after)? As the spread becomes increasingly favorable for the underdog, the bookie entices contrarians to take the bet.
And let’s face it – the bookie wants contrarians to take the bet. Otherwise, if no one takes the underdog’s side, there is no market. Nevertheless, sometimes the bookie might be too generous, and that might be the case with KOS stock.
A Possible Hornet’s Nest Kicked
To understand why people even bother to trade options (also known as derivatives), two basic incentives exist. To be sure, multi-tiered options tactics and strategies enable numerous possibilities. However, at the core, an option buyer seeks leverage in their directional speculation. With each contract typically tied to 100 shares of the underlying security, options trading can be a powerful tool.
For an option writer, the motivation centers on acquiring income. By selling a call or put, one is effectively underwriting the risk that the option will not be profitable. Therefore, the writer can collect the maximum premium or the price that the option buyer paid to the option seller.
As implied earlier, the call writer would love to sell options with ridiculously high strike prices. This is like a bookie wanting betters to bet on a clear underdog with zero spread, meaning a straight-up wager. Well, that’s obviously unfair on both counts, so no (rational) person bites on such transactions. Therefore, in order to meet in the middle, the terms of the deal must be attractive to both sides.
With the aforementioned $7 KOS call options – which expire about a month from now – the contrarians only need to see KOS stock rise less than 8% from Friday’s closing price of $6.50 for the contracts to be profitable. On the other hand, the call writers need to wait it out for a month and hope that shares don’t rise much from here.
However, this setup seems really risky for the bears. Yes, KOS stock tripped up in the past 52 weeks. Still, the stock features high mobility based on its 60-month beta of 2.47. Obviously, this metric means that shares could move to the downside. Nevertheless, if some positive data emerges, shares could also skyrocket.
Financials Nod at the Bulls
Another factor that should add some pressure to bearish traders is Kosmos’ financials. Based on the most recent earnings report (Q3), the company posted revenue of $526.35 million, a noticeable improvement over the year-ago period’s tally of $456.06 million. In other words, it appears to be in growth mode.
Also, Kosmos’ discovery of oil in the ultra-deepwater Tiberius prospect (located in the Gulf of Mexico) augurs well for its long-term growth projections. That’s not necessarily something that may drive the near-term picture. However, it could influence market participants, given that Kosmos’ outlook isn’t based entirely on pie-in-the-sky numbers.
Is KOS Stock a Buy, According to Analysts?
Turning to Wall Street, KOS stock has a Moderate Buy consensus rating based on five Buys, two Holds, and zero Sell ratings. The average KOS stock price target is $9.19, implying 41.38% upside potential.
The Takeaway: KOS Stock is Begging for Takers
If call option sellers were only underwriting derivative risks for KOS stock at a strike price of $70, no one would take the bet. However, at $7 – meaning less than 8% from Friday’s close – it’s an attractive proposition. Financially, Kosmos is moving in the right direction, and KOS shows more than enough mobility to make up the gap, especially if some positive news breaks before the February 16 expiration date.
