Thu May 08 2014
Live Index (1454 articles)

Is an 18% Per-Year Yield Sexy Enough for You?

Over the past several weeks, there has been a dramatic transition in the U.S. stock market. You won’t notice this change by looking at a chart of the Dow Jones Industrial Average or S&P 500. But if you look deeper into some of the individual components, there are some significant changes taking place.

“Boring” has become the new “sexy” on Wall Street. Companies with exciting growth stories and blue-sky potential have seen their stock prices take significant haircuts.

Just this week, Twitter (NYSE: TWTR) hit a new low after the company reported earnings. It beat analyst estimates on certain metrics, but losses widened. Shares of Facebook (NASDAQ:FB), (NYSE: CRM) and LinkedIn (NYSE: LNKD) are well off their recent highs as well, just to name a few.

Meanwhile, reliable companies such as Caterpillar (NYSE: CAT), Johnson & Johnson (NYSE: JNJ) and Home Depot (NYSE: HD) are all near 52-week highs. Even blue-chip tech companies with reliable earnings, such as Cisco (NASDAQ: CSCO) and Intel (NASDAQ: INTC), are holding up well.

There’s no denying it — safe stocks have become very attractive to institutional investors. And that trend is likely to continue as long as volatility in speculative stocks keeps risk high.

With that in mind, I want to set up an income opportunity today in a reliable company that has a stable business and pays a generous dividend. While the company certainly has attractive growth potential, the stock is priced reasonably and its stability should attract capital from institutional investors seeking safety.

Potash Corp. of Saskatchewan (NYSE: POT) is the world’s largest producer of potash fertilizer and the third largest nitrogen producer. Fertilizer companies stand to benefit in an environment of rising agriculture commodity prices because farmers have an increased incentive to use more fertilizer to boost yields. The stock is currently trading at about 18 times expected earnings for 2015, with significant potential for those expectations to increase.

Commodity prices for potash have been under pressure following the breakup of a cartel agreement between potash producers in Russia and Belarus. The breakup sent shares of POT sharply lower in July, but since the initial drop, it has been steadily recovering.

While a reunion of the cartel is certainly not a probability worth making an investment decision on, the possibility remains that a new agreement could be reached. This would be bullish for POT, as it would help to boost potash prices.

But even without a new agreement, strong crop prices, which naturally lead to demand for fertilizer, should continue to drive shares higher. POT also has a 4% dividend yield that should make it attractive to institutional investors seeking stability and income.

Today, we have an opportunity to generate income at a rate of 18% per year by selling putsagainst this stock. With POT trading at $ 36.57 at the time of this writing, the POT June 36 Puts are trading near $ 0.82 per share.

By selling these puts, we collect $ 82 per contract in premium upfront and are undertaking an obligation to buy shares of POT at the $ 36 strike price should the stock be trading below this level when the puts expire on June 21. Given the positive outlook for fertilizer companies right now, I would be happy to buy the stock at a discount to today’s price.

Since we are accepting this obligation, we need to set aside the necessary capital in case shares are assigned. We will be receiving $ 82 per contract from selling the puts, so we will need to set aside an additional $ 3,518 to cover the potential purchase.

Assuming the stock stays above $ 36 and our puts expire, our income of $ 82 represents a 2.3% return on the capital we set aside in 47 days. That translates into a per-year rate of return of roughly 18% — not bad considering the relatively low level of risk given the bullish trend for fertilizer stocks.

Selling puts is an excellent way to generate income in your investment account while also creating an opportunity to buy quality stocks at a discount. In fact, my colleague Amber Hestla has used this same strategy to “steal” thousands of dollars at a time from Wall Street. By performing these “heists,” as we call them, she’s delivering annual gains of 78.8%… 125.6%… and even 212.2%. Find out how you can do the same.

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