Recommendation No. 2: Southern Company (NYSE: SO)

“Sell to Open” Southern Company November $47 Call

Option Symbol: SO121117C47

Limit Order Price: $0.74 or more

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Income

• Income generated: $74 per options contract (representing 100 shares of stock)
• 92-day rate of return at current stock price of $46.39: 1.6 percent (6.3 percent annualized)
• Tell your broker:

“I want to sell a covered call against 100 shares of my Southern Company (SO) stock. Specifically, I want to ‘sell to open’ one November $47 call for a credit of $0.74 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 Southern Company:

Buy/Write on Southern Company (NYSE: SO): Buy the Stock and Simultaneously “Sell to Open” the November $47 Call

Option Symbol: SO121117C47

Limit Order Price: $45.65 or less (stock is at $46.39 and November $47 call is at $0.74)

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Income

• Net cost of buy/write: $4,565 per 100 shares
• 92-day return if stock does not move: 1.6 percent (6.3 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 Southern Company (SO) and ‘sell to open’ one November $47 call for a net debit of $45.65 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 Southern Company (SO) for $46.39 per share or less.”

Trade No. 2:

“I want to sell a covered call against 100 shares of my Southern Company (SO) stock. Specifically, I want to ‘sell to open’ one November $47 call for a credit of $0.74 per share or more.”

Please note: When doing a buy/write trade in two steps rather than in one simultaneous trade, the important thing is limiting the net cost of the buy/write to $45.65 per share. The specific limit prices of the individual “buy stock” and “sell covered call” trades are just starting points and should be adjusted as needed, keeping the net cost of the overall buy/write in mind.

• Ex-Dividend Date: The stock’s next quarterly ex-dividend date is November 1st. If the November $47 call is in the money at that time, there is a chance that the call owner will opt to exercise the option early in order to capture the $0.49 quarterly dividend. In such a case, an early roll of the covered call may be warranted.
• Why the November $47 Strike?: Personal Finance associate editor Roger Conrad has set a “buy below” target of $42 on the stock. With the stock currently trading 10.5 percent above this target at $46.39, it is prudent to sell a covered call at the $47 strike. Southern is performing well, but second-quarter earnings per share were flat and revenue fell 7.5 percent on a decrease in total energy sales per customer. In the short term, sluggish demand for electricity could crimp further price appreciation in the stock.

Price Adjustments Regarding This Trade

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

Investment Rationale for Underlying Stock:

Southern Company (NYSE: SO) is a public utilities holding company and one of the largest generators of electricity in the US. The Georgia-based company serves 4.4 million customers in Alabama, Florida, Georgia and Mississippi. The utility boasts 43,000 megawatts (MW) of annual electricity generation capacity.

At present, shares of Southern’s stock trade at a relatively high price, a consequence of many risk-averse investors’ apparent willingness to pay any price for stocks perceived as “safe.” Indeed, there was little to fret about in what were very solid second-quarter earnings for the company, despite the impact of mild weather in early spring. The company even saw some signs of recovery for its commercial customers, a lagging segment since the Great Recession of 2008-09.

However, Southern does face challenges over the next several months that could take its share price back to Personal Finance associate editor Roger Conrad’s recommended entry price of 42, if not lower.

The first such challenge is the question of cost recovery for an integrated gasification combined cycle (IGCC) coal plant in Mississippi. The state Supreme Court threw the project into uncertainty by overturning regulators’ previous granting of rate increases for recovery of construction work in progress.

Regulators have created a temporary solution until the problem is finally resolved. And even if no recovery is forthcoming until the plant is finished, it won’t be a major blow to Southern’s profits.

Second, the US Department of Energy is still negotiating with Southern over the agency’s initial agreement to provide $8.3 billion in federal loan guarantees for the construction (currently underway) of two nuclear reactors at its Vogtle nuclear plant in Georgia. The delay in financing is in large part due to the Obama administration’s embarrassment over its previous loan guarantees for the now-bankrupt Solyndra, a situation that’s entirely different.

These two new 1,100 MW nuclear units are scheduled to start operation in 2016 and will double Vogtle’s current 2,430 MW capacity.

Finally, Georgia regulators are expected to issue their ruling on cost recovery at Vogtle by August 21. There’s no reason to expect there will be anything but full recovery of costs.

Although the shares trade above the recommended buy target, the southeastern electricity giant is otherwise a very safe utility pick. Its stock was barely scratched by the 2008 crash and subsequent recession, losing just 0.2 percent in 2008, a year in which the Dow Jones Utility Average fell more than 30 percent and the S&P 500 was down 37 percent.