Get a Discount on Kosmos Energy (KOS) Despite the Risky Oil Market

Josh Enomoto - Barchart - Tue Aug 8, 2023

At first glance, the concept of betting on the long side for upstream oil specialist Kosmos Energy (KOS) seems risky, in large part because of the Federal Reserve. With policymakers again resuming interest rate hikes to combat stubbornly elevated inflation, this framework doesn’t bode well for commoditized industries. So, while KOS stock has been up this year, the price action has been incredibly choppy.

Still, options traders apparently see upside opportunity with KOS stock, with Kosmos drawing significant attention during Monday trading. Fundamentally, the bullishness isn’t entirely unjustified. While monetary policy headwinds pose significant challenges, nuances in the consumer economy may help undergird optimism. In addition, with so many investors walking away from the hydrocarbon space, KOS appears undervalued.

KOS Stock Lights Up the Board for Unusual Options Activity

Following the close of the Aug. 7 session, KOS stock represented one of the top highlights in Barchart’s screener for unusual stock options volume. Typically, investors monitor unusual volume to determine what the smart money is doing, implying big moves ahead for the affected securities.

For KOS stock, total options volume reached 12,185 contracts against an open interest reading of 21,032. Further, the delta between the Monday session volume and the trailing one-month average metric came out to 1,004.71%. Drilling down, call volume hit 11,674 contracts while put volume only mustered 511, leading to a put/call volume ratio of 0.04.

Notably, the put/call open interest ratio stands a bit higher at 0.21. Nevertheless, both ratios imply greater proportion of interest in call options.

Among individual transactions, the calls with a $7 strike price and an expiration date of Aug. 18, 2023 represented the most unusual activity in terms of the volume-to-open-interest (Vol/OI) ratio, which came out to 12.78X. For this trade, the bid-ask spread as represented by the midpoint price (43 cents) landed at 11.63%. It’s an in-the-money transaction, given that KOS stock closed at $7.33 on Monday.

Interestingly, the third-most unusual option based on Vol/OI ratios was the $8 call. Here, the aforementioned metric came out to 3.38X with an implied volatility of 51.06%. The bid-ask spread as represented by the midpoint (28 cents) printed a lofty 17.86%.

Despite the wide spreads, traders in the derivatives market and investors in the open market continue to bid up KOS stock. Two technical factors help the cause. First, the Barchart Technical Opinion indicator rates KOS a 40% buy, noting a strengthening short-term outlook.

Second, Wall Street analysts have a consensus strong buy view on Kosmos. This assessment breaks down as four strong buys, one hold and significantly zero sells. In addition, the median price target for KOS stock stands at $8.95, implying 22% growth potential from Monday’s close.

Fundamentals Also Make a Solid Case for Kosmos

Against the immediate framework, KOS stock admittedly appears risky. On Monday, the company disclosed its results for the second quarter. Earnings, when adjusted for non-recurring costs came out to 6 cents per share. On the top line, Kosmos posted revenue of $273.3 million. However, these line items missed their respective consensus targets of 9 cents and $300.51 million.

Nevertheless, for contrarians, KOS stock could be intriguing. First, shares appear undervalued. Currently, the market prices Kosmos at 7.22X forward earnings. However, the upstream oil and gas sector’s average forward multiple stands a bit higher at 8.58X.

Second, the fundamentals appear to be surprisingly robust for the hydrocarbon sector overall. In particular, the revenge travel phenomenon that catapulted domestic and global tourism as COVID-19 restrictions broadly faded continues to provide a positive catalyst. As such, higher travel equates to increased consumption of hydrocarbons, raising demand.

Of course, if economic conditions fade as certain pressure points – namely stubborn inflation – cloud the wider narrative, the rising return-to-office mandates could force increased demand for hydrocarbon products. It’s cynical reasoning, obviously. However, the bullish contrarianism toward KOS stock may be more than skin deep.

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On the date of publication, Josh Enomoto 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.