Calendar Spread on Kinder Morgan (KMP)

STRATEGY DISCUSSION: Kinder Morgan (NYSE: KMP) ended the last trading session at $76.34. So far the stock has hit a 52-week low of $63.42 and 52-week high of $78.00. KMP has had an S&P 5 STARS (out of 5) ranking since 8/23/2007.  On 4/21/2011 S&P equity analysts set a 12-Month price target of $88.00 for the stock. Kinder Morgan stock has been showing support around $75.18 and resistance in the $76.98 range. KMP is part of the S&P 5 STARS stock list.  A way to play this stock would be with a calendar spread that substitutes a longer term call option in place of the covered call stock purchase. To use this strategy consider going long the KMP Jan ’13 67.50 Call and selling the Jan ’12 75 call for a $6.00 debit. The strategy has an 82 day life and would provide 3.72% downside protection and a 25.00% assigned return rate for an 111.28% annualized return rate (for comparison purposes only). This strategy has a 3 Key (out of 5) Moderate Relative Risk ranking.  Kinder Morgan has a current annual dividend yield of 5.91%.

TRADE: A CALENDAR SPREAD that involves selling the January ’12 75 call and buying the January ’13 67.50 call should cost $66.89 less per share than the covered call and potentially yield a 25% return if the stock stays above $75 through expiration.  S&P set a $88.00 12-Month price target for KMP which is currently trading at $11.66 below that target.  With the calendar spread trade, the trade cost could be reduced and returns potentially improved if the stock stays above $73.55 but lower than $95.43.

RISK: The Calendar spread strategy will normally carry more risk than a covered call strategy, but the rate of return is generally higher, since there is a lower capital outlay. At a 3 Key risk ranking this strategy is considered to have moderate relative risk. If the stock price at expiration is below $75 this strategy will not generate the potential returns shown. Another risk for this strategy is related to the bought Call Option price.  If the stock drops in price between now and expiration date, there is a possibility that the Jan ’13 67.50 call could drop quickly.

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