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Solar Threatens Utilities

40% From This Stock

Written by Briton Ryle
Posted June 4, 2014

Solar power is making serious headway in the U.S... and it's not just utilities.

Bloomberg reports that residential deployment of solar panels is up 38% so far in 2014. Total installations are up 79% over last year.

Part of the reason for this is financing. Companies like Solar City (NASDAQ: SCTY) have made financing solar panels for your home easy and affordable.

Cost also plays a roll. The cost of solar panels has come down precipitously in the last few years.

I expect some people still think solar power is something of a fad that won't ever have a big impact on overall energy consumption.

But the truth is that solar power may prove to be highly disruptive to the energy sector.

Last week, Barclays downgraded the corporate bonds of the utility sector.

That's right, the entire utility sector got a downgrade because of solar power. Here are a couple quotes from the research:

Electric utilities… are seen by many investors as a sturdy and defensive subset of the investment grade universe. Over the next few years, however, we believe that a confluence of declining cost trends in distributed solar photovoltaic (PV) power generation and residential-scale power storage is likely to disrupt the status quo. Based on our analysis, the cost of solar + storage for residential consumers of electricity is already competitive with the price of utility grid power in Hawaii. Of the other major markets, California could follow in 2017, New York and Arizona in 2018, and many other states soon after.

In the 100+ year history of the electric utility industry, there has never before been a truly cost-competitive substitute available for grid power. We believe that solar + storage could reconfigure the organization and regulation of the electric power business over the coming decade. We see near-term risks to credit from regulators and utilities falling behind the solar + storage adoption curve and long-term risks from a comprehensive re-imagining of the role utilities play in providing electric power.

Investors may be also wary of optimism about solar power, given a recent history of losses in that industry. We believe that sector spreads should be wider to compensate for the potential risk of regulator missteps and/or a permanent change in the utility business model.

This is important news. I expect not many Wealth Daily readers own utility bonds directly. And if you do, I doubt there will be a mad rush for the exits.

The bigger story here is the viability of solar power. There is still a huge opportunity for investment in the solar power sector, and I've got just the stock for you...

This Solar Stock is CHEAP

Trina Solar (NASDAQ: TSL) has a forward P/E of 8. It trades at book value, and earnings estimates are being revised higher. With two quarters left in the current year, Trina is expected to earn $1.15 a share this year. Next year, it's expected to earn $1.47.

That's a pretty good jump in earnings. The stock could easily be 40% higher in a few months. But I'd like to show you a simple strategy that could boost those gains by an additional 32%...

Let's say you just bought 1,000 shares of Trina Solar. Shares currently sell for ~$12.50, so you invested $12,500. Now let's suppose I told you I might want to buy your shares of Trina Solar at $14, only I need to wait until July 19 to decide, but I will pay you an additional $600 to hold your Trina Solar shares until then.

The $600 is yours to keep, whether I end up buying your stock or not. And you could make an additional $1,500 on the stock itself. You're total take could be $2,100, or 16%.

And because you've already taken $600 in cash, you've lowered your risk on the stock.

So, would you do this? Would you be willing to lock in 10%-15% gains on every stock you bought just for agreeing to sell it at a higher price a month or two in the future?

If so, you might be happy to learn that this type of transaction has a name: a covered call option. 

Experienced investors use covered calls to boost their gains all the time. They also help protect you from downside losses.

Here's how they work...

When you sell a covered call, you are selling the right to buy stock you already own. You get paid cash right away, and even better, you can agree to sell your stock at a higher price than what you paid!

The call option is said to be a “covered” call because the obligation implicit in the call option contract is “covered” by the stock you own.

Covered calls are no more risky than owning stock. In fact, because you can use them to create a revenue stream, they are actually less risky than simple stock ownership.

Still, many individual investors can't see past the risk of buying options, and so they miss out on this great source of income.

Easy Income with Covered Call Options

Stocks don't always move as we expect. That's just a fact.

I'm bullish on solar stocks and Trina, but I'm not naive enough to think the stock will only go higher. I've been doing for this nearly 20 years, and if there's one thing I've learned, it's that stock prices go up and down — regardless of fundamentals.

But a low-risk covered call strategy can smooth out the market's ups and downs and give you thousands of dollars in income a year.

Let's go back to the Trina Solar example.

I recommended this stock to a group of investors back in March around $15 a share. Yes, it's lower now, I got it. But we've taken $1.10 a share in income from two covered call sales. And we will likely sell some more covered calls on Trina in the next few days to boost our income to around $1.70.

By the end of this year, we will likely take in around $4 a share in income from Trina Solar. The stock could still be below our entry point, yet I expect we'll be showing a profit on the investment.

That's the power of using covered calls to boost your returns.

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Risk and Reward

When you buy a call option, you're betting that the stock will go higher. If it does, you will likely make money. If it moves sideways, you will likely lose some money. And if the stock goes down, you could lose a lot, or even all, of the money you put into the trade.

In other words, you will only make money in one out of the three possible scenarios. The other two end with you losing money.

Covered calls, as you've seen, are a whole different ball game when it comes to risk and reward.

For starters, when you sell a covered call, you keep that money. It's yours regardless of what happens to the stock.

If the stock rallies past the price at which you agreed to sell, you keep the money from the covered call plus the profit from the stock. If the stock moves sideways, you keep the covered call money and the stock, and you are free to sell another call, taking in more money.

If the stock moves down — which is always a risk in the stock market — you have the cash from covered call sale to offset the stock price decline. Here again, though, you still have the stock and will be free to sell another call, take in more cash, and further offset any losses.

There are no limits to how many times you can do this.

There aren't many win-win situations in the stock market. Covered call trading maybe the closest thing to it.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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