Rail stocks typically generate stable profits as companies in the industry often have well-diversified customer bases. For example, electric power plants are heavily dependent on railroads to deliver the coal necessary to run the plants, thus providing stable income for railroad companies even in difficult economic periods.
At the same time, railroads are able to benefit from an increase in economic activity through their shipment of raw materials, merchandise and other economically sensitive freight. And let’s not forget the agricultural products that are shipped by rail — products that count as staples for consumers even when the economy is challenged.
In recent years, a few key railroads have also added a new line of revenue to their portfolio: natural gas.
The natural gas fracking boom has led to a supply glut in the US. With so much supply, it has taken some time for the market to begin to absorb the resource. However, as power companies transition to running their turbines on natural gas and more natural gas vehicles hit the road, demand is slowly starting to catch up to supply levels.
But there is still one major problem for natural gas producers. The nation’s network of pipelines simply hasn’t expanded fast enough to reach all of the areas where natural gas is being pulled out of the ground. And without pipelines in place, it is extremely difficult (and expensive) to transport the gas to end users.
So rail companies are working with producers to liquefy the natural gas and transport it by rail rather than by pipeline. The additional revenue stream is just another opportunity for the rail companies to further diversify their income.
Kansas City Southern Put Selling Strategy
Today, I want to take a look at a put selling strategy that has strong potential to generate a 12% per year income stream in your portfolio, with a shot at allowing you to buy shares of a healthy rail company at a significant discount.
Kansas City Southern (NYSE: KSU) is one of the rail companies that is well-positioned to take advantage of the natural gas opportunity. The stock has been moving steadily higher over the last year as investors gain confidence in the overall industry.
Kansas City Southern (NYSE: KSU) has pulled back from recent highs, in line with the current market weakness. This pullback has the stock trading near a key support level just above $100 per share. The pullback works in our favor as put sellers for two reasons:
1. A lower stock price means that we can sell puts that allow us to buy the stock at an even more attractive valuation.
2. As the stock trades lower, the premium for options increases, giving us more income for our put selling strategy.
Today, I want to sell KSU Oct 100 Puts, which are trading near $1.95. By selling one put option contract, we are obligating ourselves to buy 100 shares of Kansas City Southern (NYSE: KSU) at $100 per share should the stock drop below this price point when the puts expire on the third Friday in October.
Considering our obligation, we will want to set aside enough capital in our account to be able to buy the stock if it trades down to this level. But keep in mind, we sold the puts for $1.95, so our net cost would actually be $98.05 per share, or $9,805 per contract, an 8.5% discount to recent prices.