Energy Transfer Equity LP (NYSE:ETE) reported earnings and it’s falling 2% in pre-open trading. These days, investors are unforgiving when management misses the mark. There are too many great reports so the bad ones are punished. Luckily, analyst expectations are low for ETE stock.
Coming into its earnings, it was trading below the lowest of the price targets on Wall Street. Now and after the earnings reaction, ETE is still trading 10% below the average of the range. So the good news is that when expectations are humble this lessens the likelihood of a slew of downgrades from disappointments.
Technically, ETE has had a 17% rally in under two weeks, so this 2% dip in the stock on the headline is normal. Furthermore, the rally came from a hard bounce off $16-per-share. This gives me confidence that traders see value in it.
And therein lies my opportunity.
Here’s How to Play ETE Stock
I want to sell downside risk against this perceived value. If the price holds up for the next six months, then I would have generated income from thin air. Otherwise, I could temporarily own shares of ETE.
Fundamentally, ETE stock is cheap from a price-to-earnings ratio perspective. But it being a derivative off Energy Transfer Partners LP (NYSE:ETP), it’s hard to really valuate it. Suffice to say, the P/E and margins are good enough reason for me to trust the price action. So I consider this trade setup a true calculated risk.
Technically and for over a year, ETE bulls have successfully defended the $15/$16 zone. Prior to that and during the energy price crisis of 2015, it fell to $8.
I believe that often, traders overreact so that $8 is an extreme that is not realistic in today’s macroeconomic environment. Usually, somewhere in the middle lies the truth. So at $30, it was too high just as at $8. it was too low.
I consider this a mid-term bet on the price action. The goal is to generate income with options and no out of pocket expense. My risk level has been a pivot point since 2013, so it’s likely to be sticky on dips.
The Trade: Sell the ETE Apr 2018 $15 put for 75 cents. This is a bullish trade that does not require a rally to profit. Here, I have an 85% theoretical chance of success, but I would accrue losses below $14.25.
The Alternate Trade: Sell the ETE Apr 2018 $15/$14 bull put spread, which has about the same odds of winning and would yield 40% on risk. Compare this with risking $18.50-per-share without any room for error, expecting a rally profit.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Get my newsletter for free here. 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 as @racernic on twitter and stocktwits.