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Peabody Energy (NYSE:BTU) is one of the world's largest coal producers. As coal has been under serious pressure for the past 12 months, BTU shares have suffered. Recently, Bank of America set a price target of $22/share, and currently rates shares an underperform. Many SA articles have looked into the fundamentals of coal generally and BTU specifically. Most recently, a fundamental article by Matt Schilling concluded that he may consider a position if BTU were to fall below $19/share.

If you want a fundamental analysis, you will have to look at these other articles. By way of opinion (my fundamental analysis is beyond the scope of this article), I will say that I consider BTU a good buy at or below $24, with a medium to long time horizon (six months to five years). Let's place fundamentals aside for a moment. On a technical level, it looks like BTU has bottomed in the high teens and low 20s. And, the price volatility makes its options premiums attractive relative to the share price.

Consider the three following options trades. The conservative trade is for investors who agree with Matt, that BTU is a buy below $19/share. The moderate risk trade is for those who think the recent $22 target by BAC is within reason. The more aggressive trade is for those (like me) who think that BTU is worth north of $25 per share, and accept 2013 to be good for the coal space.

Prices reflect a BTU close of 22.94 on 9/24/2012, and options prices are the mid point of the Bid-Ask spread at the time of writing.

Conservative:

  • Sell the March 2013 $18 Puts for $1.20
  • BTU would have to fall 21.5% for the put to be exercised
  • If the stock is put to you, the effective buy price would be $16.80
  • The "effective" buy price is well below most fundamental targets
  • Depending on your broker (and how much margin/cash they hold to secure the puts), you earn between 14% and 44% annualized return if the put expires worthless. 14% reflects the return for 100% cash secured puts, while 44% reflects the return for a 30% margin secured put.

Moderate Risk (Example values using 1000 share maximum allocation):

  • Buy BTU at $22.94 (Buy 500 shares for $11,470)
  • Sell the January 2013 $23 Calls for $2.3 (Sell 5 contracts for $1150)
  • Sell the January 2014 $20 Puts for $3.55 (Sell 5 contracts for $1775). If exercised in 2014, this would give you 1000 total shares of BTU at 18.55 average price (after options premiums, assuming the put was exercised and the call expired worthless).
  • Total initial net cash outlay is $8545.
  • There are too many possible outcomes here to analyze in great detail. But, if your stock is called away in January 2013, you would pocket the entire call premium ($1150) and would show a gain on your 2014 puts, which you could keep open or close at that time. I would keep them open, since that would give you another chance at BTU with a buy price of $16.45 in 2014. If BTU dropped, your calls would expire worthless, and you could resell the calls in January for extra premium.

High Risk (Example values using 1000 shares):

  • Sell 10 contracts of January 2014 $23 Puts at $5.10 (Net $5100 credit).
  • Buy 10 contracts of January 2014 $20 Calls at $6.25 (Net $6250 debit).
  • Your net cash outlay is only $1150 dollars.
  • If BTU is below $20 in January 2014, you will take ownership of 1000 shares at an effective price of $24.15 (Exercise price of $23, and the $1150 earlier cash outlay). Since I am happy buying BTU now at this price, I am certainly OK doing it in 2014 and meanwhile putting the money to work elsewhere.
  • If BTU is between $20 and $23 in January 2014, you will own 1000 shares of BTU at an effective price of $24.15 (because the puts will exercise), but your call will have some value (up to $3, or $3000).
  • If BTU is above $23 in January 2014, you will be exposed to 1000 shares of BTU at $20. So, if BTU is $30, your call is worth $10,000 and the put is worthless. So, your $1150 cash outlay returns 870% in a year with only a 30% gain in a beaten up BTU.

In my personal portfolio, I employ a combination of these strategies to maximize return and keep my risk profile at a comfortable level. Obviously, what options strategies you chose will depend on your risk tolerance and your time horizon.

Source: BTU: 3 Options Strategies To Maximize Return