Generate a Potential 102% Per Year in Income on This Comeback Story

Solar stocks remain at the top of my list of strong investment candidates as we head into the end of 2013.

The industry staged a dramatic turnaround earlier in the year as a supply glut of solar modules finally worked its way out of the market and demand began to increase. In particular, Japan’s transition from nuclear power to renewable sources of energy helped to drive strong demand for solar products.

At the same time, advances in technology have allowed solar power to essentially reach grid parity — where solar energy is produced at essentially the same cost as power produced from fossil fuels — which is helping drive demand in other developed nations.

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Higher levels of demand allowed solar panel manufacturers to increase shipments of products earlier this year, a change that caught investors’ attention. The entire group has traded sharply higher with many solar stocks more than doubling in price over a few short months.

Along with the higher levels of demand, solar manufacturers have begun to discuss plans for increasing capacity, which is a dramatic shift given that the issue of overcapacity drove several competitors out of business.

A Consolidation Sets Up Opportunity

Following the run up over the summer, solar stocks have settled into a consolidation pattern for the past several weeks. This is natural for any group that has experienced tremendous gains over the past several months. Traders typically want to take some of their profits off the table, which can create overhead resistance.

In the case of solar stocks, lower oil and natural gas prices may also be a factor as recent bearish price action can decrease the costs of producing electricity from fossil fuels, and thus erode a bit of solar power’s immediate competitive edge.

At any rate, solar stocks as a group are still holding up relatively well and should continue to trend higher as global demand supports growth in the industry. The current consolidation sets up a put selling opportunity to create additional income in our accounts and possibly pick up some exposure to the group at discounted prices. And with prices backing off a bit, volatility levels are increasing, which in turn boosts prices for the put option contracts.

Today, I want us to sell puts against Trina Solar (NYSE: TSL), a leading solar stock that just posted its first profit in nine quarters. The stock has become much more volatile in recent weeks, while still trading near the top of its range.

TSL Stock Chart

The TSL Dec 15 Puts are trading near $1.20 per share. With TSL currently at $15.25, these puts are out of the money. TSL could fall more than 1.6% before dropping below the $15 strike price, causing us to be assigned shares.

Since we will receive $120 per contract for selling the puts, we will only need to set aside an additional $1,380 per contract to cover our obligation to purchase the stock if it trades below $15.

If TSL remains above $15 through December option expiration, we will be able to keep the $120 with no further obligation, generating an 8.7% rate of return in 31 days. If we could repeat a similar trade each month, we could generate 102% per year.

Of course, your return may be a bit higher or lower depending on what price you receive when executing the trade, but there is no question that the higher implied volatility in these put options makes for an attractive potential return.

Assuming TSL does not remain above $15 through options expiration, we will then be obligated to buy 100 shares at $15 apiece. Because of the $1.20 premium we collected, our net cost basis for the stock should be $13.80, a 9.5% discount to the current price.

I would be more than happy to pick up shares of TSL at that price, especially considering the long-term recovery that is in play for solar manufacturers. So, whether we are able to generate a high rate of income or buy shares of this strong stock at a discount, selling puts against TSL looks like a very attractive proposition.

Note: By using this same income-generating strategy, my colleague, Amber Hestla, has helped her Income Trader members earn an average return of 8.6% every 48 days. Click here to learn how you could do the same.