Under $10 Turnaround Story Could Yield 47% a Year in Income

Solar stocks have been commanding attention as advances in technology have made it possible to generate power at costs that are now on parity with more traditional methods such as coal and natural gas. With "grid parity" now a reality, profitable business lines are emerging for solar manufacturers, allowing these companies to meet demand from both institutional and retail clients while generating positive profit margins.

Shares of JA Solar (NASDAQ: JASO) look particularly interesting at this point for a number of reasons.

First, the company announced last month that it is now mass-manufacturing modules that are built on its latest cell technology, which achieves 20.4% power efficiency on average. This surpasses the industry standard and puts JASO in an enviable position. This could allow JASO to sell its merchandise at premium prices, resulting in wider profit margins in an industry that is becoming increasingly commoditized.

Second, the company is turning the corner from posting losses to generating profits. In the June and September quarters of last year, JASO reported losses of $0.54 and $0.36 per share, respectively. In the December and March quarters, it was able to post small profits of $0.01 and $0.06 per share, respectively.

Analysts now expect JASO to report earnings per share of $0.21 for the June quarter and $0.37 for the September quarter. Clearly, the company is in a key transition period that could ignite investor interest as profits roll in. JASO has not yet announced a date for its earnings release, but sources estimate it will be toward the end of August.

Third, the stock trades at a very attractive valuation. The consensus estimate for 2014 is for earnings of $1.35 per share, and analysts are pegging 2015 earnings at $1.52. JASO is trading at just 7.2 times this year's expected earnings and 6.4 times 2015 expected earnings. Certainly, there is some risk with analysts' assumptions, but the discount seems excessive given the company's evolving turnaround.

Today, I want to set up an income opportunity by selling puts. Specifically, I want to sell the out-of-the-money JASO Aug 9 Puts for a limit price of $0.40 per share. For each put option we sell, we will receive $40 in income, as each contract represents 100 shares.

By selling these put options, we are accepting the obligation to buy 100 shares of JASO per contract at the $9 strike price if the stock is trading below this level when the puts expire on Aug. 15.

As you can see in the chart below, $9 has acted as a floor for JASO for the past several months.

JASO Stock Chart

My expectation is that this floor will remain in place, but even if JASO drops below $9 and we are required to buy shares at this level, it would be an attractive spot to own this solar manufacturer with plenty of upside potential if the stock rebounds.

For every contract that we sell, we will need to set aside $860 of our own capital (in addition to the $40 option premium) in case we wind up being assigned shares.

If JASO remains above $9 as I expect and the options expire worthless, the $40 in income represents a 4.7% rate of return on our $860 that we set aside. Since this will be realized over 36 days, this nets out to 47% on a per-year basis.

The reason we can generate such a high rate of return is in part due to the elevated option premiums across the board in solar stocks. The industry is in a transition period, and there is a large amount of uncertainty. This increases the overall risk, but our timing should serve us well. 

We are able to set up this income trade during a period where JASO is pulling back, so our bullish trade is established at a relatively low price point. Also, the pullback helps to increase the premium in the option contracts, which gives us more income on our trade.

If we are required to buy shares of JASO, we will have a number of options for what to do with our new position. Some traders may choose to wait for a rebound to sell. You can see in the chart above that JASO has a history of sharp rallies that should give traders a chance to sell at a profit. Other traders may wish to hold JASO with a longer time horizon. This may make sense because of the discount valuation and the dynamic shifts under way for the entire industry. 

Still other traders may choose to sell covered calls against the position to generate more income. Since volatility and uncertainty affect both call and put option premiums, the calls should continue to trade at high prices, giving ample opportunity for generous income.

Note: My colleague Amber Hestla has closed 52 straight winning trades using this strategy. You can see her entire track record and learn exactly how you can make the same winning trades yourself by following this link.

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