Recommendation No. 2: Enterprise Prod. Partners (NYSE: EPD)

“Sell to Open” Enterprise Products Partners June $52.50 Call

Option Symbol: EPD120616C52.5

Limit Order Price: $0.50 or more

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Income

• Income generated: $50 per options contract (representing 100 shares of stock)
• 57-day rate of return at current stock price of $51.40: 1.0 percent (6.2 percent annualized)
• Tell your broker:

“I want to sell a covered call against 100 shares of my Enterprise Products Partners (EPD) stock. Specifically, I want to ‘sell to open’ one June $52.50 call for a credit of $0.50 per share or more.”

• Remember: You should only sell one call option per 100 shares of stock purchased. The trade can only be done in 100-share increments (100, 200, 300, 400, 500, etc.).

Alternative Trade for Those Who Don’t Already Own Enterprise Products Partners:

Buy/Write on Enterprise Products Partners (NYSE: EPD): Buy the Stock and Simultaneously “Sell to Open” the June $52.50 Call

Option Symbol: EPD120616C52.5

Limit Order Price: $50.90 or less (stock is at $51.40 and June $52.50 call is at $0.50)

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Growth

• Net cost of buy/write: $5,090 per 100 shares
• 57-day return if stock does not move: 1.0 percent (6.2 percent annualized)
• Brokers vary as to whether they call this trade a “buy/write” or a “covered stock” trade.
• Do the trade simultaneously at a single limit price, if possible. For example, if you want to buy 100 shares of stock, tell your broker:

“I want to do a buy/write trade. Specifically, I want to buy 100 shares of Enterprise Products Partners (EPD) and ‘sell to open’ one June $52.50 call for a net debit of $50.90 per share or less.”

• Some brokers require that you buy the stock and sell the call in separate trades. If your broker is one of these, always buy the stock first and sell the call against it second:

Trade No. 1:

“I want to buy 100 shares of Enterprise Products Partners (EPD) for $51.40 per share or less.”

Trade No. 2:

“I want to sell a covered call against 100 shares of my Enterprise Products Partners (EPD) stock. Specifically, I want to ‘sell to open’ one June $52.50 call for a credit of $0.50 per share or more.”

• Ex-Dividend Date: The stock’s next quarterly ex-dividend date is April 26th. Since this ex-dividend date is almost two months prior to June options expiration, the time value associated with the June $52.50 call–combined with the amount by which the $52.50 call is out of the money–is very likely to be larger than the $0.6275 quarterly dividend and there is little chance of early exercise to capture the dividend.
• Why the June $52.50 Strike?: According to Personal Finance associate editor Roger Conrad, Enterprise Products Partners has “surged above our buy target” of $45 by more than 10 percent. On the positive side, high prices for natural gas liquids (NGLs) are expected to continue, which ensure that the master limited partnership’s pipeline transportation business will remain strong and its stock price won’t fall much. With additional capital appreciation unlikely, however, generating some additional income at a call option strike near today’s current stock price makes sense. We don’t want to get assigned on the covered call and lose the stock, so we need to choose a strike price above the stock’s current $51.40 price.

Price Adjustments Regarding This Trade

Stock prices are currently fluctuating and option prices fluctuate with them. Consequently, the limit prices recommended in this trade may no longer be immediately fillable by the time the alert has been released. The alerts are valid for seven trading days, so be patient and place your limit orders as “good ‘til cancelled” for seven trading days.

Investment Rationale for Underlying Stock:

Enterprise Products Partners LP (NYSE: EPD), one of the largest publicly traded master limited partnerships (MLP) in the US, boasts a diversified business mix that includes natural gas pipelines, offshore production platforms, oil pipelines and even tank barges.

Roughly 70 percent of Enterprise Products Partners’ revenue comes from pipelines and other assets that generate fees regardless of whether they operate at full capacity. These fee-based businesses limit sensitivity to commodity prices and broader economic conditions.

In 2011, Enterprise Products Partners generated record distributable cash flow (DCF) of $3.7 billion, which included about $1 billion in cash proceeds from asset sales. That was enough to cover the company’s full-year 2010 distribution of $2.435 per unit by 1.35 times.

Don’t assume that Enterprise Products Partners’ conservative, fee-based business model limits its growth prospects. Management makes a strong case that the potential returns from organic growth projects, such as constructing new pipelines and processing facilities, exceed returns available from acquisitions in the markets it serves. The company is putting money behind this strategy, investing $6.5 billion in growth projects slated to come online between 2012 and 2014.

As part of this effort, the company continues to shrewdly tap the capital markets to finance new projects while interest rates remain near historic lows. In February, for example, Enterprise Products Partners issued $750 million of bonds maturing in August 2042 at a yield to maturity of just 4.85 percent. This issue will pay off $500 million of 7.625 percent notes maturing next year. Enterprise Products Partners is slashing interest costs and locking in cheap capital to fund a projected $3.5 billion in expansion spending in 2012.

Enterprise Products Partners has a tremendous advantage over all but a handful of MLPs when it comes to spending on growth initiatives: The MLP enjoys one of the lowest costs of capital of any partnership. Despite boosting its distribution in all four quarters of 2011, Enterprise Products Partners’ healthy cash coverage means the MLP retained about $1.7 billion in DCF.

Although the MLP operates several different business segments, about half the firm’s gross operating margin–a measure of core profits that excludes noncash charges–comes from pipeline and services related to natural gas liquids (NGL) such as ethane, propane and butane.

This business unit includes 25 natural gas processing plants, 21 NGL fractionators, extensive NGL pipelines and storage capacity, and NGL import-export terminals along the Gulf Coast. This segment is not only the company’s most important source of cash flow but also its most compelling growth opportunity.

One of the company’s key organic expansion projects involves the construction of NGL infrastructure in the Eagle Ford Shale, including 300 miles of natural gas pipelines, a processing plant with a capacity of 600 million cubic feet of natural gas per day, two major NGL pipelines, a new crude oil terminal in Houston and a fractionation facility in Mont Belvieu, Texas, a key hub for NGLs.

Although producers have fought tooth and nail to obtain the best acreage in the Eagle Ford shale, Enterprise Products Partners has become the region’s dominant provider of midstream infrastructure with relative ease. Enterprise Products Partners has signed long-term agreements with all of the major producers operating in the region. These contracts guarantee the profitability of its midstream assets before construction gets underway. Enterprise Products Partners LP is rated a buy below 45 in the Personal Finance Income Portfolio.