This Trade Targets a 100% Potential Return by April

Editor’s note: In this new daily column, Rick Pendergraft shares one of his favorite option trades for the current market. Each trade offers defined risk and typically targets 100%-plus potential returns. Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis.

Option Trade Of The Day: Kinder Morgan (NYSE: KMI)

Energy and oil service stocks have been rallying over the last few months, but the gains within the groups have varied quite a bit.

Exploration and production companies, as well as oil equipment companies, have performed better on average than the pipeline companies.

The sentiment toward the entire energy sector has gotten overly optimistic in recent weeks and I wouldn’t be surprised to see oil prices slip a little in the coming weeks.

That being said, I was scrolling through the charts from my bearish scan last night when I took note of the chart for Kinder Morgan, an oil and gas pipeline company.

I took note that the stock has been moving lower over the past year and had formed a trend channel and was near the top of the channel.

We see from the 10-day RSI and the daily stochastic readings that KMI is in overbought territory on both indicators and reversed a liitle on Friday. I look for that reversal to continue and for the stock to drop below the recent low in the $16.75 area.

I also looked at the overall sentiment toward Kinder Morgan and what I saw was that on January 2, the sentiment reading hit the second highest reading for the past year, meaning extreme optimism toward the stock. Historically high or optimistic extremes in sentiment have marked tops for the stock.

Buy to open, the Mar18, 20 strike puts on KMI. These options expire on March 16. Based on previous declines, that should be sufficient time for a dip in the stock. The stock closed at $18.86 yesterday and based on the previous downward cycles, I expect a decline of at least 12.5% which would take the stock down to the $16.60 level and would make this option worth $3.40 on an intrinsic basis. The asking price on the option was $1.59 at the close yesterday and I would recommend entering at $1.70 or lower. This would mean a double for this option.

— Rick Pendergraft

OPTIONS DISCLAIMER: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, investorservices@theocc.com.

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Rick Pendergraft, Trades Of The Day

Rick Pendergraft has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick's analysis process includes fundamental, sentiment and technical analysis.