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Use Covered Calls for Extra Energy Income

Selling covered calls on stocks you own can mean more income in your IRA


Most income investors are familiar with the concept of buying “gatekeeper” companies in sectors that have a high barrier to entry, whether because of high startup costs or sheer brand loyalty. Warren Buffett’s Coca-Cola (KO) purchase is probably the most famous example, but you can find many gatekeepers in utility stocks like General Electric (GE) and Exelon (EXC). This is an area I think that investors who are aggressive about generating income can really take advantage of—whether with a simple buy or a covered call strategy.

So it might surprise you to hear that one of my favorite gatekeeper stocks for income is in the oil and natural gas area.

Most high-yield income investors want an energy component within their portfolio as a long-term cornerstone against inflation. That makes perfect sense, but only if that income vehicle can stand the test of time. This is achieved by replenishing reserves at a rate higher than those energy assets to the marketplace at whatever the prevailing prices are.

You can only imagine what happens to the share price of trusts such as the Sabine Royalty Trust (SBR), a royalty trust that only has assets in oil and nat gas properties, in the long run. Sure, they get a pop when crude jumps to $100 per barrel, but eventually they run out of oil and gas to sell to the market.

Think about it: Which company would you rather own: the one tied to the fluctuating prices of a finite resource, or the one with a virtual monopoly on the transport of that resource to energy-hungry developing nations?

A perfect example of the latter is Cheniere Energy Partners (CQP), which owns the Sabine Pass Terminal, the first liquefied natural gas terminal in the United States. Coincidentally, it’s in the same area as SBR, right by the Gulf of Mexico. It takes years to create terminals like these, and CQP remains first to market. Though other companies are building their own terminals, Cheniere Energy Partners will continue to enjoy a virtual monopoly in getting LNG to foreign markets, over the next few years

Due to more and more wells opening up nationwide, natural gas prices have generally been in decline, so LNG projects have seen a psychological boom in the form of huge investments designed to get producers out of this rough patch. For example, venture capital giant Blackstone Group (BX) invested $2 billion in Cheniere Energy Partners, underscoring institutional enthusiasm for what lies ahead for the export of LNG to gas-hungry nations in Asia. What an endorsement of this mega-investment theme.

Recommendation: CQP’s business is sound, and it currently yields 5.70%, which should make income investors pretty happy. I recommend entering the stock under $30.10.

Covered Call Strategy: For those who would like to earn additional “income” on CQP, I recommend a covered call strategy. Covered calls are allowed in an IRA, so even retirement-minded investors can take advantage of this strategy.

For best results, buy 100 shares of CQP under $30.10 for each CQP September 32 call that you sell to open at 90 cents per contract. Be patient with these calls, as they still need some time to reach that 90-cent level.

By selling covered calls, you have the obligation to deliver 100 shares of CQP at $32 to the buyer, should they exercise the call before the option expires. If this happens, your potential gain is 9.30%. In either case, you keep the initial $90 from your sale.

Bryan Perry is the editor of Cash Machine, a newsletter focused on high-yield income investing with a the goal of maintaining a blended total yield of 10% across two portfolios. Bryan is also the editor of Extreme Income which uses the power of historically cheap money to create a leveraged “baby hedge fund” strategy that paves the way to massive profits and 4x greater income.

Stay tuned! Bryan is currently working hard on a brand new strategy that amplifies your income potential by utilizing a conservative options strategy based on stocks you may already own.

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