LIVING OFF DIVIDENDS & PASSIVE INCOME

I read an email today that mentioned China (who is already the planet’s largest coal consumer) claims it will need an extra 80 million tons by next January. India is also estimated to need an extra 120 million tons, and most other Asian countries are expected to increase demand by 7%.

According to Kevin Kerr, “Coal prices are going much higher than I thought. Keep an eye on those diesel prices too, they are already creeping up. These two markets are going to surge this summer, absolutely.”

Since I like to take advantage of investment opportunities whenever I come across them, I placed an order to sell PUT option contracts on James River Coal Company (JRCC). Its essentially a long position on the companies stock, which has nicely trended up 50% in the past several months.

If the order is executed tomorrow (the order was placed after hours) I get a net credit of $195/contract. By september, if the stock trades above $8.05, I’ll have made a profit. My maximum profit is $195/contract and it occurs at stock prices over $10.00. If the stock drops below $8.05 I will either have to buy it or sell my option before expiration date at a loss. But I’m bullish on the stock so the loss would be smaller than actually buying the stock outright.

If the stock stays at the same $9.50 price, I’ll still make $145/contract at expiry. Both my upside and my downside are limited, but I think there’s a great chance I’ll make more money selling the puts with a lower risk than by buying the stock outright. Plus for each contract instead of putting up nearly $1000, I’m collecting $195 instead. It does use up my margin limits, but it does mean I don’t need to pay interest on the amount, since I’m not borrowing any money.

Of course you manage the risk here by not betting the farm. If the stock moves against me and my option moves against me 50% (ie, I’m down $100/contract) I’ll close out my position. Since this total draw-down is only 0.33% of my portforlio, it doesn’t give me ulcers. And while the total profit is only 0.66% of my total portfolio and isn’t exactly an earth-shattering return, its a 2-1 risk-reward scenario that I’m comfortable with.

If the stock goes BK overnight and I lose the max $805 per contract, it still only 2.66% of my portfolio, which is a bearable loss. Remember, risk management will determine whether you succeed or fail in the long term.

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