Earn a Potential 29% Annual Yield on This Stock Without Ever Owning Shares
One of the great things about our put selling income strategy is that we can use short-term challenges to our advantage. For instance, when a stock moves lower because of a temporary issue, we can capitalize on the uncertainty, capturing more option premium from our put options. And we can sell contracts with a lower strike price, reducing our risk on the trade.
Today, I want to use the recent weakness in natural gas prices to set up an income trade on Encana Corporation (NYSE: ECA).
You may remember that natural gas prices spiked this past winter as harsh weather led to an increase in demand. As we moved into the warmer months, natural gas prices pulled back, leading to uncertainty for the companies that drill wells and produce this important fuel source.
While spot prices for natural gas have declined more than 30% from their February peak, there are still plenty of reasons to have a long-term bullish perspective on this clean-burning fuel. In the United States, natural gas continues to be an environmentally preferred means for generating electricity. And globally, the number of natural gas vehicles on the road is expected to grow by more than 65% from 2.3 million in 2014 to 3.8 million in 2023.
U.S. natural gas prices have been volatile due to increases in supply from the widespread adoption of fracking coupled with uncertainty regarding demand growth. From a short-term perspective, it appears prices have found support in the past month. And longer term, the more widespread adoption of natural gas as a fuel for vehicles, along with better transportation solutions such as improved pipelines and LNG terminals, could help to steadily push prices higher.
Shares of Encana stand to benefit from rising natural gas prices. The company holds a diverse portfolio of properties producing oil, natural gas and natural gas liquids. But it is primarily known for its natural gas wells. As such, the stock often trades in a similar pattern as natural gas spot prices.
Today, ECA is trading near $22 per share and appears to be rebounding from recent weakness due to the decline in natural gas prices. Our put selling strategy should allow us to generate a 29% per-year rate of return.
To set up this trade, we are going to sell the ECA Oct 22 Puts for a limit price of $0.90 per share. By selling these put contracts, we are obligating ourselves to buy 100 shares of ECA per contract at the $22 strike price if the stock closes below this level when the puts expire on Oct. 17.
Since we are receiving $0.90 per share ($90 per contract), our net cost is lowered to $21.10 per share. Therefore, we will need to set aside $2,110 per contract along with the options premium to cover the potential obligation.
My expectation is that the stock will climb at least modestly over the next few weeks and close above $22 on expiration. If this scenario pans out, we will be able to keep the $90 per contract free and clear, earning a 4.3% return. Since this will be generated over the next 54 days, our per-year rate of return nets out to 29%.
However, if ECA is below $22 when the puts expire, the owner of these contracts will have the right to “put” shares to us — selling us 100 shares per contract at $22 per share. But as I said, since we received $0.90 per share for selling these contracts, our net cost will actually be $21.10 per share, 4% below the current price.
Being assigned shares is certainly not a bad outcome. In fact, selling puts is the closest to a win-win strategy as you’ll find in the markets. You can either generate high levels of income or have the chance to own shares of a stock you are bullish on at a discounted price.
If we end up being put shares of ECA, the next step is to figure out what to do with this position. One attractive opportunity for us would be to “rent” our shares to other investors — much the same as a property owner might rent an investment home to a tenant.
If you’re unfamiliar with the process of renting stocks, you should definitely take a look at this strategy. By renting shares out, investors are able to capture reliable income on a monthly basis while waiting to sell their stock at a higher price. And not only do you create additional income, but you reduce the amount of risk you take on from your stock positions.
This is a strategy I used extensively when I managed investments for high net worth individuals, and it can be used in just about any brokerage account, including IRAs and other retirement accounts. To learn more about this lucrative income strategy, just follow this link.