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Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 Energy Transfer: The Perfect Options Play May 9, 2022 10:10 AM ET by: Uncle PennyBags Summary For those that play options, Energy Transfer is an ideal candidate for juicing massive income while waiting for further gains. Options on an MLP allow you to skip the K-1 at tax time, invest freely in a tax advantaged account, and are taxed lower with 1256 options tax rules. With options, an investor can apply leverage while staying off margin and a well run dividend play is the perfect candidate for this strategy. Not everybody plays in options land or has their account setup for this, and there is some inherent time risk as well as leverage working both ways, up and down, but overall a solid strategy. 1 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 Klaus Vedfelt/DigitalVision via Getty Images Seeking Alpha contributors have pounded the table on Energy Transfer ($ET) stock for, let's face it, years. The company has been covered in depth from debt, leverage, acquisitions, expansion, distributions, tax filings, and more. You name it and it's been covered here on Seeking Alpha to some degree in relation to this company, but I want to tackle a strategic angle that I think many investors might find suits them better than just buying or selling stock while adding more capital gains to their bankroll, and they might be pleasantly surprised to know they can make MORE income off this strategy than on sitting and collecting the dividend. Why options? They are absolutely properly named vehicles in every way as buying and selling stock gives you two choices, buy and hold, or sell and be out. Options give you avenues to make money while you wait, and hedge your positions, and play the swings in the stock in a more timely fashion all while giving the investor a plethora of... well... OPTIONS when it comes to making moves on their favorite names. Disclaimer: Basic options strategy is a must to know and understand before jumping into this pool because of so many moving parts and variables to take into consideration, it gets very information heavy very quickly so learning the rudimentary basics of options is a must before this article makes more sense. 2 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 You can learn about the fundamentals of options here: https://www.investopedia.com/terms/o/option.asp Why Energy Transfer? $ET is really a gem to play options on, both on the call side and the put side. I put together a list of personal requirements I constructed that outline the structure to find the best stocks ideally suited for options playing and currently, ET checks all the boxes. 1. You like the stock and want to own it. There might be scenarios where you WANT to exercise call contracts and actually own the stock itself, so typically it's a good idea to only play these strategies on something you WANT to own. 2. The stock is in an upward trajectory and bullish trend. The overall trend of the stock is key. You want a stock that at least for the next 12 months has an upward trajectory. With energy exploding higher given supply issues for rig counts, demand needs as Russian energy comes off the table, and overall move to ESG coming too soon pushing out much of the supply expansion, you have a perfect tide for upwards movement in Energy Transfer stock after a decade of energy being in the pits. 3. The stock trades under $20. This means you can sell a higher number of contracts against a cheaper price or buy much more calls with less capital which stretches your investment dollars and maximizes options gains. 3 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 For example. ET trades at $11.63 and TSLA trades at $865 A $10 call for Jan 2023 on ET trades right now at around $2.30 A $750 call for Jan 2023 on TSLA trades right now at around $250 For a $100K investment, you can buy either 435 of the ET calls or you can buy 4 of the TSLA $750 calls. More calls means you can write more covered calls against that position and juice much higher gains. It also means that even a small move in the stock equates to big gains because you have control over many more shares. 4. The stock has a large float that churns heavy volume. The stock has very heavy volume days to easily mask big blocks for lots of contracts. Also, if you get assigned, you have lots of liquidity to get in or out of your trades if needed. Liquidity is KEY in options trading when you are doing large volumes and you want tighter bid / ask spreads to which you can move more easily in and out. 5. The company has hard assets and foreseeable stable cash flows. If you get assigned, you don't want to be in a high beta stock with little assets in market volatility as we have seen currently, you want to do low beta with lots of assets so you're never truly "stuck"should the tide turn on you". It's simply for risk aversion and overall macro trends. For example NFLX options holders got absolutely crushed off of one ER release that wasn't even that bad of news. But in high growth stocks with 4 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 crazy high valuations, the demand from investors of perfection and continued growth is so constraining that one miss and the stock can sink 30% overnight. With stocks like ET that have years of hard earned assets and contracts via proper counter parties, you don't see valuations just erode overnight as you do with high growth stocks. 6. Ideally, the stock pays a dividend or distribution. If you ever get assigned, a dividend gives both a short term burst of bullishness with a built in catalyst which sends the stock green and you can wiggle out of your trades in a more predictable fashion. Many people also just choose to use upcoming earnings and dividend payouts as the ONLY time they want to play options as it happens only 4 times a year and can be quite profitable. Not to mention, dividend stocks are highly sought after for providing enough free cash flow to both grow the company as well as reward shareholders. All of these are signs of strong stocks and you want to be applying options strategies to very strong stocks vs more speculative ones. 7. The stock offers weekly options. The more options it offers, the more chances you have to do well and continuously ring the cash register on a more regular basis. Quicker options means less wait times for your puts to expire and a trade to close. For example, instead of getting paid once a quarter via the dividend, you can sell PUTS weekly or bi-weekly at prices a dollar or two below current stock price with much safety and STILL eek out much higher gains than just collecting the dividend. In fact, I have found on average I can juice 5 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 about an 18% return by milking options vs the standard 7% return collecting the dividend. 8. The stock is stable and well known. It's an older much more established company which greatly drops the risks of anything super material being released and going against your trade. IE well established sector performer and ideally undervalued compared to peers which creates a valuation moat. You don't want to be playing crazy options strategies in anything that is recently IPO'd or are dependent on a single upcoming catalyst creating a binary event. That's how novice options players can lose it all. Basic Strategy Everybody knows about the "buy low, sell high" tag line for investing, but for options contracts, it's "write PUTS and buy CALLS on dips, sell calls and buy back sold PUTS on rips" So essentially, you want to watch the stock on a fairly regular basis, and personally, I load up on a ton of far out dated calls as my "core" position. For instance, right now, I have thousands of calls in Energy Transfer that expire in January 2023, that's my core position that I will sell later this year for my longer dated bullish capital gain. However, in the mean time, I will sell covered calls against that position on stock bullish exuberance, and on dips I will sell cash secured PUTS to keep some premium. Essentially, this is having a long position where you use options to play the short term waves in the market. The ups and downs is where a lot of 6 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 money is being left on the table for those that just buy and hold dividend stocks to collect the coupon and nothing else. Playing the market volatility with options against your position gives you more income while you wait for your investment thesis to pay off. Most brokers allow you to sell calls against your further out dated leap calls as collateral as long as the strike price is HIGHER and the time until expiry is LOWER. For example, I have a thousand $10.00 January 2023 calls. Let's say the stock has a nice 5 day run and technicals get a little stretched to the high side. That's the point where I wanna sell covered calls, so I choose a SHORT TERM date, maybe two weeks out, and I go a dollar ABOVE stock price and sell calls at say .05 or .10c each. To so this and use my leap calls as collateral, I have to sell at strikes ABOVE $10 but for dates SOONER THAN my expiry of January 2023. So if I have a thousand calls, I might sell 950 contracts for a June 3rd strike price of $13 while we are sitting at $12.20 and what that does this net me? 950 calls = 95,000 shares as each call represents 100 shares, and I get .05 per share, for a total of $4,750 minus broker commissions. If the stock just ran for 5 sessions straight, the likelihood of it running up ANOTHER 10% is very slim given the monster float here, especially with only a few weeks left. Almost always, it gets tapped out to the high side and starts cooling down in some red days and those calls I sold end up expiring worthless and I KEEP the $4,750 after only 2 weeks of watching. 7 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 My long term "core" calls cost me an average of $2.20, times 1000 is an investment of $220,000, but if I can safely juice around $4500 every two weeks, that adds up to about $117,000 a year if I literally do it every two weeks, which I don't and I don't recommend it. I recommend being nimble, monitoring macro trends and events, and being flexible enough to only do it maybe once a month. Plus, if you go on vacation or can't watch the stock regularly, you might want to stay out of the options game until you come back to your trade desk. As an example, going into a big macro event like a FED meeting or something of the like, I often take a step back... "take a break" so to speak, and watch and wait to see what unfolds. These type of events are very unpredictable and can move the stock against you or with you quite quickly, so to be risk adverse, I sit back and watch more often than not. So EVERY two weeks isn't really feasible, so lets say you do it once a month on average. That's still a gross gain of $58,500 off your $220,000 investment. Taking out commissions, and taxes takes it down to about $40,000 or so, and that's an 18% return on your investment. It gets better though. In the example of ET, they are increasing the dividend back to $1.22 in what currently seems like a linear fashion. My guess, is that Q2 dividend is around .23c or another 15% over last quarter. At .23c, you can work backward math to get the industry average of 7% distribution and kinda get an idea where stock price will be at that time, all macro events and overall sentiment considered. .23 X 4 = .92 / .07 = $13.42 unit price Remember I bought my January $10 calls for $2.20 when the stock was 8 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 trading at $11.40 post dividend. That means I essentially paid $10 (strike price) plus $2.20 per share, or a total cost basis of $12.20. The stock was trading at $11.40 at that time, so that means I paid .80c OVER stock price just to have the time between MAY and January 2023 to make moves on my position. That's called PREMIUM. Fast forward to when the stock hits that $13.42 unit price. A little bit of time decay will hit my PREMIUM. So lets say premium moves DOWN from .80c to .60c. Remember, in options trading TIME LITERALLY IS MONEY. The longer I wait to do anything with my position, the more money I LOSE in premium because time is dwindling away. However, remember I'm selling covered calls against my LEAPS so I am still getting paid to wait in regular and well thought out intervals. Assuming .60c in premium, unit price at $13.42 in late July, and I own $10 calls, my calls will be having a bid on them of about $4.00 in late July. Remember, I paid $2.20 for them, and now they are at $4.00 AND I've been selling covered calls on them. Essentially I got paid 18% dividend to wait for a capital gain of ($4 / $2.20 ) - 1 = .81 or an 81% gain on investment. I paid $220K and got $400K PLUS covered call premium on the back end. Taxation Those are pretty sizable gains, but what about the taxes? If you own the units, the distribution is tax deferred and kept track of in the K-1. The payment lowers your cost basis until it reaches $0 over the years, and then you have to start paying taxes on those units, or buy more to RAISE your cost basis, the choice is yours. However, on options, selling covered 9 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 calls and letting them expire, or selling PUTS and letting them expire all create taxable events. It's also a taxable event if you sell your calls outright for that gain I spoke of above. So there is no avoiding the tax man on trading options, but there is some help on that front. Firstly, the commissions you pay on all your options trades, and they DO get expensive, are all tax deductible at the end of the year. So that helps some, but what about all those gains? Well, Energy Transfer is considered a utility company as it's an MLP, and there is a rule about taxation of options under IRS rule 1256. These options are marked all as "marked to market". What this means is that no matter when you buy or sell them, you get taxed equally on their gains and it also means that at the end of the calendar year, whether you sold them or not, your broker reports to the IRS and make you pay taxes on the value they have gained against cost basis. This taxation talk can get complicated, so I am including a link below that really focuses on just these tax rules. But the bottom line I want to hit home is, when filing taxes on the gains from these options sales in ET, you get taxed at what's called a 60/40 split. 60% of your options gains are treated as LONG TERM CAPITAL GAINS with a very low tax rate, and the other 40% get taxed as SHORT TERM CAPITAL GAINS which fits right in with your normal tax bracket. Read more here: https://www.investopedia.com/terms/s/section-1256- contract.asp Conclusion 10 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 I know there is a lot of info thrown out here and many investors can't wrap their heads around options trading. I used to be one of those investors until I sat down and really dug in to learn what I was missing, and I have to say, once you learn options and see how much you can do with less capital into MORE gains, you probably won't go back. There is a reason hedge funds apply this very same strategy month in and month out and why OPEX days come with volatility as hedge funds push a stock up or down to ensure collection of premium. In my strategy, you no longer fight the hedge funds, you are both on the same side doing the same thing. That's not to say that options investing doesn't have risks, because it does. The massive gain on the units I spoke of, well, if the stock announced some bad news out of the blue, and the stock dropped from say $11.40 to $10.50, my options would LOSE 60% of value, albeit temporarily in a market blip, it's always plausible and investors might not be able to stomach those kinds of drops. Another inherent risk, which can be easily mitigated, is the stock CONTINUING to move much higher even after a nice run up and you sold calls. If the stock goes OVER the strike you sold, there is a high likelihood that your sold calls actually get called up and then your broker gives shares to that other party and puts you on the hook for paying them back. Granted, you DO get the money of STRIKE PRICE X SHARES you sold calls against deposited in your account, so it's not like it's a terrible situation, but the stress may not be suitable for many investors. A way to mitigate this risk is "rolling a call up and out" . This means, that if you sold $13 covered calls, and the day before expiry it is trading at say $13.40 and you 11 of 12 5/9/2022, 10:26 AM Preview - Contributor Center | Seeking Alpha https://seekingalpha.com/submission/preview/5728887 know almost for sure it will close the next day over $13, you can enter a transaction where you "BUY TO CLOSE" your sold calls and at the same time "SELL TO OPEN" calls at a later date for a higher or similar strike. What this does is buy you a little more time for almost NO money lost and you just have to watch it again for a few weeks to ensure your strategy pans out. Remember, in options, time is money and these situations often have investors literally buying more time to finish out their trades. Overall, if you hover over your investments and watch them daily like I do, you are comfortable with options and what movement in the stock means for you, and you pick a winner like ET that checks all the boxes, you too can get much higher gains via options on your favorite stocks. Disclosure: I/we have a beneficial long position in the shares of ET either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. 12 of 12 5/9/2022, 10:26 AM