On Friday, I had the pleasure of hosting an all-day trading event for Godesburg Financial Publishing and Ask the Pros. If you didn’t get a chance to check it out, we gave away a report on how to start trading defensively in the new year. With market valuations at nosebleed levels, while inflation rises, investors are looking for any clue on where to put their money.
Most investors are starved for income in a zero-interest rate environment. It’s unclear how much longer stretched valuations can cooperate with concerns about economic weakness in the year ahead. One of the things that I told people on Friday was to use recent volatility to their advantage. Yes, it’s smart to buy on the sound of cannons and sell on the sound of trumpets. But we need a better strategy than just buy and hold right now.
How to Start Trading in the Energy Sector
As I explained, I’m still very bullish on the U.S. energy industry despite a hostile administration to oil and natural gas interests. Try as they might, it’s scientifically impossible to implement a massive transition to alternative energy resources in the next two decades. There isn’t enough land (and probably not enough cheap cobalt and nickel) to develop as many solar panels needed to develop the energy that the government projects.
Natural gas prices already exploded once this year in Europe. It’s fair to expect that rising electricity prices in the years ahead will force the media and liberals to reconsider their energy policies. That is, unless they have no desire to hold national power. Their political influence would start to wane in traditionally Blue states in the Northeast (you know, where it gets cold.)
So, I fully anticipate that companies that transport natural gas – a fuel that will still be the dominant source of electricity in 2050 – will continue to do well. However, it’s very difficult to predict exactly how and when these stocks will get off the floor and institutional capital will flow back into those shares.
Now, I look at Energy Transfer LP (NYSE:ET) right now and see an incredible bargain with a P/E ratio under 5 and a dividend sittng around 7.31%. But you know what’s better than a 7.3% yield over 12 months? How about an 8.5% payoff in less than 120 days. Because that’s what selling puts on ET can provide in the next four months if investors play their card right.
How to Trade a Cash Secured Put
As a quick reminder, a cash-secured put is a conservative trading strategy that allows you to pick your entry point on a stock for the long-term. In the case of Energy Transfer, shares trade for about $8.30 per share as of close on Friday. That offers the 7.31% annual dividend.
If you sell a put, you can choose the strike price and timeframe of your liking. A put gives the buyer the right but not the obligation to sell you the stock, should it fall to the strike price on or before the expiration date. If you sell a put with a strike price of $8.00, you are selling a contract for the buyer to sell 100 shares of the stock to you (per contract).
So, if you sell that $8.00 put, you will set aside the money until the expiration date (this money is your margin). In this case, selling an $8.00 put will require you to set aside $800. Now, you receive a premium for the sale of this contract. In the case of the Energy Transfer April 14, 2022, $8 put sold on Friday for $0.68.
Deeper into the Numbers
That’s a $68 premium that sellers would receive in their account right after the sale. Do the math. A sale for $68 would generate an 8.5% yield in just 118 days (on the $800 in margin). In addition, if the stock does fall under $8, your breakeven price on the trade would be $7.32 (the $8 minus the $0.68.) At under $8.00, you would be able to take delivery of the stock.
If the contract expires above $8, you pocket the premium and can make the same trade again if you’d like (selling puts). And if ET stock goes higher, you’ll see the value of the put you sold decline. You can buy it back at a discount and close a winning trade. This is a win-win-win strategy.
But there’s one more win: ET has a very secure dividend. If the stock does fall to $8.00, you’d lock in a stock with an even better dividend than you have today. At $8.00, ET’s dividend would sit at 7.6%. For the long-term, I’d be happy with that annual yield.