Although the stock performance for the last few years doesn’t show it, Kinder Morgan Inc (NYSE:KMI) stock has its fans on and off Wall Street. Dividends have historically been magnetic attracting traders into stocks that pay them. Perhaps muscle memory keeps them coming back in this case.
We are in a rate tightening cycle, so soon enough investors should eventually have alternatives to dividend-paying stocks as sources of fixed income. So stocks like KMI may continue to suffer more downside pressure.
Nevertheless, today I am setting a bullish trade on KMI, but one that doesn’t need a rally to deliver profits. My goal is to create income from the price action in Kinder Morgan stock. To do that, I sell downside risk against support.
This is a rinse-and-repeat trade for me in KMI, so I come into it with profits in hand.
Trading KMI Stock
An integral part of this strategy is the fact that KMI stock trades with a price-to-book ratio of 1. So, under current macroeconomic conditions, I am confident that if I have to own shares, I would be able to manage out of them with little problem. So in essence, I believe in the KMI stock support more so than prospects for a rally. Yet, should one ensue it would also help me book my profits even faster.
The major hurdle with this is that fundamentally, KMI is not cheap. It trades with a price-to-earnings ratio over 30. Usually I sell my risk against value, but in this case I have to do it against the price action itself.
A P/E of 30 is a premium I expect from a stock that rewards its holders. But Kinder Morgan stock is down 15% year-to-date and 50% in five years, so I’d say that it is not the case here.
Compare that to Apple Inc. (NASDAQ:AAPL) which is the best company on the planet and it trades with a P/E of 20, so I consider this trade somewhat speculative in a conservative portfolio.
Furthermore, expectations are high on Wall Street. KMI stock is trading 6% below the lowest of the price targets and 20% below the average. So analysts are still optimistic about its prospects. But the longer it stays far below their price range, the higher are chances of downgrades.
The Trade: Sell the KMI Jun 2018 $16 put and collect 60-cents-per contract to open. This is a bullish trade where I have a 75% theoretical chance of success. But if I am wrong and prices falls below my strike, then I accrue losses under $15.40-per-share.
Selling naked puts can be risky. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the Jun KMI $16/$14 credit put spread, where I have about the same odds of winning. but with much smaller risk. Yet, the spread can potentially deliver 25% in yield.
Ultimately, 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.
