Kinder Morgan Inc (NYSE:KMI) has had a bad 12 months, but it’s been on the recovery path in 2016. Since late January, KMI stock has had a nice uptrend. It has traded inside an clear ascending channel and has been well-behaved, consistently reverting to the mean.
Usually, I like to sell risk against edges of predictable channels. Trades like these are the definition of calculated risks. I sell risk knowing I have a certain theoretical chance of success. If I am right, then I profit. If I’m wrong, I incur losses of a predetermined amount.
Fundamentally, KMI is an energy infrastructure company, so it’s price sensitive to the energy prices. Considering a floor in energy, however, the downside disaster scenario was addressed already this year.
When the Federal Reserve raises rates, Kinder Morgan’s stock price could be at risk from the ensuing spike in the U.S. dollar. Strength in the U.S. dollar puts downside pressure on energy prices.
When selling risk, headlines are my enemy. Analysts that cover KMI are equally split between “buy,” “outperform” and “hold.” So there is no obvious threat from surprise changes in ratings. The KMI dividend also poses a threat. Stocks usually move unpredictably on news of changes in dividend policy.
Trade #1 – The Long Bet: Sell the KMI Dec $20/$19 credit put spread. This is a bullish trade for which I collect 24 cents per contract to open. Ideally, I need KMI to stay above $20 per share to yield over 25% on money risked. This has an 75% theoretical chance of success. Normally I need a bigger price buffer but I am making an exception with this 6% buffer. I will have tight stops.
Usually I like to hedge my bet with an opposing trade.
Trade #2 – The hedge (Optional): Sell KMI Dec $23/$24 credit call spread. This is a bearish trade for which I collect an additional 16 cents per contract. Here I need KMI stock price to stay below my sold strike to win.
If I take both trades I would have sold an iron condor. In total I would have collected 40 cents per contract. Taking both trades also reduces the dollars at risk thereby raising the potential yield to over 50% if KMI stays between both spreads sold.
This is a tighter-than-ideal iron condor setup but is somewhat justified by the high overall yield. I am not obliged to hold these trades through their expiration. I can close either for partial profit or losses at any time.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
