CHK June Put Volume Spikes After S&P Says Chesapeake Could Breach Covenant (Update 2)

Even after Chesapeake Energy received a $4 billion unsecured term loan (without covenants) from institutional investors to "repay borrowings under the company's existing corporate revolving credit facility", which would support billions in asset sales ($9.5-$11B is their target), S&P downgraded Chesapeake's credit rating to 'BB-', further into junk territory. But most importantly, S&P said that Chesapeake could breach the "debt to lagging-12-month EBITDA" covenant within the next three quarters. As a result, out-of-the-money put volume spiked in June.

-- Chesapeake recently announced that it had entered into a $3.0 billion unsecured loan facility, maturing on 2017, with proceeds to be used to repay borrowings under the company's existing corporate revolving credit facility. Borrowings may be repaid at any time this year without penalty, and Chesapeake has stated it intends to do so, out of asset sale proceeds. This transaction was costly for Chesapeake: it carries an initial variable annual interest rate through Dec. 31, 2012, of LIBOR plus 7.0%, which is currently 8.5%, given the 1.5% LIBOR floor in the loan agreement. Subject to certain limitations, the interest rate would step up to a fixed rate of 11.5% if the loan is not repaid by May 11, 2013.

-- Although this $3 billion debt issuance enhances near-term financial flexibility, we believe there is a risk of constraints on Chesapeake's ability to draw on its corporate credit facility. Among other maintenance financial covenants under the facility, there is a reported total debt to lagging-12-month EBITDA limit of 4.0X. We believe that if EBITDA remains at the weak level of the first quarter ($838 million) or worse, as we anticipate, without a significant reduction in reported total debt from the level at March 31, 2012 ($13.1 billion), Chesapeake could breach this covenant within the next three quarters.


"Based on our estimates and price deck assumptions (including natural gas price of $2.00 per British Thermal Unit in 2012, $2.75 in 2013, and $3.50 thereafter), we expect Chesapeake's negative free cash flow to total over $16 billion during 2012 and 2013."

As a result of this news, or a desperate need for downside protection, I saw that CHK June Puts were very active over open interest. These strikes stood out the most. OptionMonster saw a put spread in there. Look at the option chain below.

June 7 puts traded 61,441 times with 1,082 contracts open.
June 12 puts traded 41,734 times with 8,164 contracts open.
June 15 puts traded 23,146 times with 14,249 contracts open.
June 11 puts traded 13,569 times with 4,125 contracts open.

Source: Google Finance

These were mostly out of the money puts. Here was the range of activity on the stock chart.

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