The Stock Option Writer
© Warren Kaplan 2011-2012
October 23, 2012
The main point I would like to make in all of my articles is that you should never buy any stock without a real good reason and goal. Some goals can be short term and some can be long term. Years ago, Warren Buffett had long-term goals and he stuck with them. I presume his company is still looking long term when they make an investment. Then again, you have to decide how long is long term? Twenty years ago, you might have liked General Motors, K-Mart, Bethlehem Steel and Eastman Kodak. Well since then, they all went bankrupt and shareholders were wiped out. So, when I discuss a stock, my aims are basically short term. The only investments I feel will work long term is the S&P 500 and the SPDRS.
So why KMP? Well that is for you to decide.
From the Yahoo financial site:
“Kinder Morgan Energy Partners, L.P. operates as a pipeline transportation and energy storage company in North America. Its Products Pipelines segment delivers gasoline, diesel fuel, jet fuel, and natural gas liquids to various markets through approximately 8,400 miles of refined petroleum products pipelines; and operates 60 associated product terminals and petroleum pipeline transmix processing facilities. The company’s Natural Gas Pipelines segment gathers, transports, stores, treats, processes, and sells natural gas through approximately 16,200 miles of natural gas transmission pipelines and gathering lines, as well as natural gas storage, treating, and processing facilities. Its CO2 segment produces, markets, and transports carbon dioxide through approximately 2,000 miles of pipelines to oil fields that use carbon dioxide to increase production of oil. This segment also owns and operates 8 oil fields, and a 450-mile crude oil pipeline system in west Texas. The company’s terminals segment trans loads, stores, and delivers bulk, petroleum, petrochemical, and other liquids products through approximately 115 liquids and bulk terminal facilities; and approximately 35 rail trans loading and materials handling facilities. Its Kinder Morgan Canada segment transports crude oil and refined petroleum products through approximately 2,500 miles of pipelines from Alberta, Canada to marketing terminals and refineries in British Columbia, the state of Washington, and the Rocky Mountains, as well as in the central regions of the United States. This segment also operates the Jet Fuel aviation turbine fuel pipeline that serves the Vancouver (Canada) International Airport. Kinder Morgan G.P., Inc. serves as the general partner of the company. Kinder Morgan Energy Partners, L.P. was founded in 1992 and is headquartered in Houston, Texas. Kinder Morgan Energy Partners, L.P. operates as a subsidiary of Kinder Morgan, Inc.”
Basically, the company provides a means of transportation for oil and gas. KMP is not really involved in the price of the commodity. Rather, in the quantity that is used. With natural gas prices being cheap, then they will transport more. Regardless of how high price oil goes, what is used must be transported. In a sense, this company has become a utility. The capital structure is different from the general company that one invests in. The company is set up as a partnership. What trades (KMP) is a unit that represents a piece of the partnership. It is limited as to liability. Your return is based on free cash flow and not reported earnings. You will receive a quarterly distribution based on “suitable” cash flow meaning that debts and expenses have to be paid first. You will receive a K1 for tax purposes and that is mainly considered a return of capital. A well-trained broker or financial partner should be able to explain all of the benefits to you and the potential pitfalls. All investments have potential pitfalls so don’t let that word scare you.
The stock closed at $84.71 on Friday, October 19, 2012. That was down $1.15 for the day. If you focus on the days up and down, you will miss opportunities. The stock will have a distribution of $1.26 for unit holders of Oct 31 and it will be payable Nov 14th. Last year, the distributions were $4.70 and then rose to $4.92. The new rate seems to be $5.04 and that works out to an annual rate of 5.95%. As the company grows, distributions should continue go up. This is one company that the Chinese cannot compete with.
Writing the January put at $80.00 will bring you $1.45, which is more than the distribution. Also, at $80.00 the stock would have to decline another 5.56%. If you do get put, your cost is $78.55 so your yield rises to 6.42%. It is not magic, it is math. If you want more protection, you can write the Jan 2013 put at $75 and take in $.95. If you get assigned, your yield will be 6.81%. Remember that Jan 2013 options are only three months away. Longer-term options, due January 2014, which is 15 months away, will bring you $7.50 for the $80.00 put and $5.25 for the $75.00 put. If the stock price goes down the premium you can get for the put will be greater than what I am showing you here. Also, there are a variety of strike prices. You should work closely with your financial ad visor as to a strategy that you feel comfortable with. A strike price is the price you contract to buy or sell at. You can buy the units at $84.71 and sell a call that expires in January 2014 and receive $3.55. That would add to the distribution amount of $6.30 that is expected in that time period. If the unit gets called away on the last day at $85.00, your total return would be $10.14 on your base investment of $81.16 for a total 15-monthh return of 12.49%, which is an annual return of 10.00%.
As you can see, there are endless possibilities using option writing to increase income and thereby decrease risk. Caution: you write a put and the stock collapses in price, you will have the potential to sustain a large capital loss. This happened in the 2008-09 crash but it was less a loss than if you did not write any options.
Covered call writing is Level 1 and it is basic to learn that first. Level 2 allows you to write cash covered puts. I do not suggest that you go above Level 2. These articles are to show you another facet of investing. It is not for everyone.
Warren Kaplan has been writing options for 50 years. He has been a stockbroker, investment banker and brokerage owner. He currently owns and operates Kaplan Asset Management, a provider of financial assistance for small to middle market businesses. He has more than a half-century of experience in dealing with financial markets, giving guidance and consulting with management, and assisting in the development of business strategies and solutions. The Company has assisted and consulted many successful companies, such as Natures Bounty (NBTY) and Action Products International (APII), helping them to go public and trade on the NASDAQ stock exchange. His philosophy is to “do something with the profits.” “If you make $100 in the stock market, take 50 percent and invest it back into the market. Then, take the other 50 percent and buy yourself something.”
Reader’s comments are welcome. Please do not consider these opinions as advice and we take no responsibility for any trades made. You should review these option writing ideas with your financial advisor so that you are properly guided. Writing options is not for everyone. If you want information about a certain stock, please email email@example.com.