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Under $7 Stock Offers Income Ahead of a Potential Bounce

Basic materials have bounced back from concerns of a global slowdown led by China that never materialized.

Steel has been a relative outperformer in this recovery, as evidenced by the chart below comparing United States Steel (NYSE: X) and metallurgical coal producer Alpha Natural Resources (NYSE: ANR). X is up more than 65% since its April lows, while ANR is down slightly during that time.

ANR vs X Chart

Coal has a dirty image as an energy source, especially when compared with cleaner and plentiful natural gas. However, metallurgical coal -- or coking coal -- is a vital ingredient in the steel-making process.

This coal producer could start to play catch-up with steel stocks. ANR has remained above the $6 price pivot level for almost six weeks, and this is support to watch on a weekly basis. The 52-week low sits below at $4.78.

ANR Stock Chart

If you are comfortable holding on to this inexpensive stock for a potential recovery, then selling puts could allow you to collect income while you wait to get into ANR at a 15% discount.

Cash-Secured Put Selling Strategy

While the typical investor might use a limit order to buy a stock or ETF at a designated price or lower, the options trader can do one better by selling a cash-secured put option.

This strategy has the same mathematical risk profile as a covered call. When selling puts, there is an obligation to buy the stock at the option's strike price if it is assigned, allowing you to get into the stock at a discount. In fact, the true entry cost basis is even lower with the subtraction of the premium you earned from selling the puts.

And if the stock is not below the strike price at expiration, then the premium received is all profit. In other words, you're getting paid not to own the stock.

There are two rules traders must follow to be successful at selling puts.

Rule One: Only sell put options on stocks you want to own.

The intention of the put selling strategy is to be assigned the stock as a long-term investment. Each option contract represents 100 shares, so make sure you have the funds in your account to buy the stock at the option's strike price if a sell-off occurs. Paying in full ensures that no additional money is needed to hold the stock for potentially many months or even years until a price recovery.

Rule Two: Sell either of the front two option expiration months to take advantage of time decay.

Collect premium each month from selling puts until you are assigned shares at a cost-reduced basis. Every month that you keep the premium is money subtracted from your entry price.

Recommended Trade Setup: Sell to open ANR Jan 6 Puts at $0.25 or better. (Use a limit order to get the desired price.)

This cash-secured put sale would assign long shares at $5.75 ($6 strike minus $0.25 premium), which is about 15% below ANR's current price, costing you $575 per option sold. If the put option expires worthless, you keep the $25 premium, earning a potential 4.3% return in 46 days.

Remember, you should only sell this put option if you want to own ANR at a discount to the current price.

If you are assigned the shares, a February covered call can be sold against the stock to lower your cost basis even further. If ANR does not fall below the strike price before expiration, then you keep the premium you collected, essentially getting paid not to buy the stock.

Note: By using this same income-generating strategy, my colleague, Amber Hestla, has helped her Income Trader members earn $6,000... $19,500... even $150,000 this year alone. Click here to learn how you could do the same.

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