Republican Win Could Lead To A 42% Gain From This Oil Stock

The market has yet to start talking much about the effect of the Republicans winning a majority in the Senate next month in the midterm elections. While the longer-term effect on stocks based on which party controls Congress is widely debated, there is good reason to believe that a change in power this year could lead to a surge in today’s pick. 

Despite the correction in the past few weeks, stocks have been on an amazing run since the market bottomed in 2009. Much of the jump in asset prices is thanks to extremely accommodative Federal Reserve policies, and I would not normally be inclined to bet one way or another on midterm elections.

#-ad_banner-#‚ÄčExcept for this year.

The market has been so preoccupied with October volatility, Ebola and geopolitical concerns that it hasn’t yet reacted to the possibility that congressional control may be about to change.

The Republicans currently hold the House of Representatives with 233 members versus 199 Democrats. The Democrats hold the Senate with 55 seats compared with 45 Republican seats. 

Most polls give the Republicans a strong chance at winning the six seats needed to take the Senate. For example, the Senate forecast model at puts the GOP’s odds at 63%.

The market jumped last time the Republicans swept through Congress, taking the House and picking up Senate seats in 2010. The S&P 500 traded flat for most of the period up to the beginning of November, before rallying 3.6% the week of the elections. Energy companies did even better with a 5.2% rise in the Energy Select Sector SPDR (NYSE: XLE).

SPX vs XLE Chart

Keystone is the Key

A Republican win this year could be even better for the energy sector and one company in particular. Approval of the Keystone XL pipeline has been held up in Washington as President Obama sides with environmentalists. Republicans have vowed to put the pipeline on fast track next year if they win control of the Senate.

The GOP, along with some Democrats, have only been able to pass a symbolic measure in support of the pipeline, but Democrat Majority Leader Harry Reid has blocked a vote on the project itself. With the Senate in the hands of the Republicans, a vote would likely be held early next year. The president could still veto the approval if less than a two-thirds majority voted in favor, but that would put the White House in a tough political spot. 

Whether the pipeline is ultimately approved or not, a Republican win could push shares of Valero Energy (NYSE: VLO) much higher in November. Valero is the world’s largest independent refiner with 2.9 million barrels per day of throughput capacity.

Approval of the Keystone XL pipeline would bring cheap Canadian oil sands crude directly to the Gulf Coast, where Valero has most of its refining capacity. Western Canadian Select (WCS) crude trades for one of the highest discounts to Brent crude of any type of oil. That means huge margins for Valero if it can increase its supply of the cheaper oil.

Strong Cash Flows Through New MLP Creation

The company created Valero Energy Partners (NYSE: VLP), a publicly traded master limited partnership (MLP), in late 2013 to more efficiently manage assets. 

Valero maintains 69% ownership of the MLP and expects at least 20% average annual distribution growth over the next three years. VLO will benefit as it sells assets down to the MLP to raise cash for growth projects. 

VLO is returning significant amounts of cash to shareholders. It doubled its cash return to shareholders in 2013, and it looks like management intends to increase it further this year. The company repurchased 10.4 million shares so far in 2014 for $559 million and has paid out $266 million in dividends.

Capture Quick Upside With a Covered Call Strategy

Not only is there a good chance of upside on a Republican win of the Senate, but Valero is scheduled to report third-quarter earnings on Nov. 4. Earnings are expected to come in at $1.53 per share, 168% higher than the same quarter last year. The company has beaten expectations by an average of 15% over the past four quarters.

To take advantage of near-term upside, we can set up a covered call strategy.

With VLO trading at $48.30 at the time of this writing, we can buy the stock in 100-share lots and simultaneously sell one VLO Dec 50 Call for every 100 shares purchased. The options are currently trading around $1.50 ($150 per contract), which lowers our net cost to $46.80 per share. 

If VLO is above the $50 strike price at expiration on Dec. 20, our shares will be sold for that price. In this case, we will make $1.70 in capital gains plus the $1.50 in options premium for a total profit of $3.20 per share in 59 days. This is a 6.8% return over our cost basis. If we were able to make a similar trade every 59 days, we could earn a 42% rate of return in a year.

I like the trade as long as we can get in for a net cost of $47.20 or less, which still leaves us with a gain of nearly 6% in two months if the shares are called away. If the shares are still below $50 by expiration, we keep the call premium and can sell more calls on later expirations. 

Lower oil prices, especially for Brent crude, have weighed on refiners, but strong demand for gasoline as the U.S. economy continues to rebound should help support the group over the next year. Valero is well positioned to benefit from the potential passage of the Keystone XL pipeline, and investors could see a near-term pop come the November elections.

Note: Selling covered calls is like collecting “rental income” on the stocks you own. If you’re not renting out the stocks in your portfolio, you may be missing out on the easiest income around. See how you can collect $1,200 or more each month by clicking here.

This article originally appeared on Republican Win Could Be the Ticket to Fast Profits in This Oil Refiner