Recommendation No. 2: Genesis Energy LP (NYSE: GEL)

“Sell to Open” Genesis Energy LP December $35 Call

Option Symbol: GEL121222C35

Limit Order Price: $0.55 or more

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Income

• Income generated: $55 per options contract (representing 100 shares of stock)
• 92-day rate of return at current stock price of $33.32: 1.7 percent (6.5 percent annualized)
• Tell your broker:

“I want to sell a covered call against 100 shares of my Genesis Energy LP (GEL) stock. Specifically, I want to ‘sell to open’ one December $35 call for a credit of $0.55 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 that Don’t Already Own Genesis Energy LP:

Buy/Write on Genesis Energy LP (NYSE: GEL): Buy the Stock and Simultaneously “Sell to Open” the December $35 Call

Option Symbol: GEL121222C35

Limit Order Price: $32.77 or less (stock is at $33.32 and December $35 call is at $0.55)

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Income

• Net cost of buy/write: $3,277 per 100 shares
• 92-day return if stock does not move: 1.7 percent (6.5 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 Genesis Energy LP (GEL) and ‘sell to open’ one December $35 call for a net debit of $32.77 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 Genesis Energy LP (GEL) for $33.32 per share or less.”

Trade No. 2:

“I want to sell a covered call against 100 shares of my Genesis Energy LP (GEL) stock. Specifically, I want to ‘sell to open’ one December $35 call for a credit of $0.55 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 to limit the net cost of the buy/write to $32.77 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-Distribution Date: The stock’s next quarterly ex-distribution date is around November 1st. If the December $35 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 $0.46 or higher quarterly distribution. In such a case, an early roll of the covered call may be warranted.

• Why the December $35 Strike?: Personal Finance has set a “buy below” target of $30 on the stock. With the stock currently trading 11.1 percent above this target at $33.32, it is prudent to sell a covered call at the $35 strike. Genesis’ crude oil pipelines are performing very well, but the US economy remains sluggish, which could crimp crude oil demand and prices in the coming months.

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:

Genesis Energy LP (NYSE: GEL) managed to keep its streak of quarterly dividend raises intact throughout the financial crisis and Great Recession, a testament to management’s conservatism and shrewd maneuvering. In fact, the master limited partnership (MLP) just announced its 28th consecutive distribution increase, the 23rd of which exceeded an annual growth rate of 10 percent. A 35 percent upsurge in available cash before reserves, the account from which the company draws its distribution, enabled the MLP to cover its payout by 118 percent.

The firm owns a diverse portfolio of midstream assets, including refinery-related plants, pipelines, storage tanks and terminals, marine operations and trucks and truck terminals. The MLP operates three business lines: pipeline transportation, refinery services and supply and logistics.

The pipeline transportation business includes crude oil pipelines and carbon dioxide pipelines in Texas and the Gulf Coast. Over the past few years, management has focused on increasing the MLP’s exposure to two of the premier oil plays in this region: the Permian Basin and the Gulf of Mexico.

The firm acquired two carbon dioxide (CO2) pipelines from its former general partner (GP), Denbury Resources (NYSE: DNR), that transport naturally occurring CO2 from Jackson Dome to the Permian Basin, where Occidental Petroleum Corp (NYSE: OXY) and other producers pump the gas into mature reservoirs to improve recovery rates. Some of this oil enters Genesis Energy’s pipeline system for transportation to refineries in Texas City.

Over the past two years, the company has taken advantage of favorable pricing to add to its portfolio of pipeline interests in the Gulf of Mexico.

Genesis Energy made its first move in November 2010, acquiring a 50 percent stake in Enterprise Products Partners LP’s (NYSE: EPD) Cameron Highway System. This joint venture comprises 380 miles of pipelines that transport crude oil from a number of trends in the deepwater Gulf to refineries in the Texas City area.

In December 2011, Genesis Energy announced several related deals to build its asset base in the deepwater Gulf of Mexico. We expect these moves to prove prescient as oil and gas drilling activity gradually recovers in the region.

The MLP acquired a 28 percent stake in the Poseidon System, a 29 percent ownership interest in the Odyssey System and a 23 percent stake in the Eugene Island pipeline system from Marathon Oil Corp (NYSE: MRO) for $205.9 million.

The firm also inked a joint venture with Enterprise Products Partners to build a 149-mile crude oil pipeline that will connect the Lucius development to the Seaway Pipeline System. This project is backed by contracts with a number of major producers, including Anadarko Petroleum Corp (NYSE: APC), Eni (Milan: ENI, NYSE: E), ExxonMobil Corp (NYSE: XOM) and Petrobras (NYSE: PBR).

Genesis Energy’s refinery services operations include sour-gas processing facilities collocated at nine refineries. In general, the MLP’s compensation for these services allows it to take possession of the removed hydrogen sulfide, which is combined with other compounds to produce sodium hydrosulfide and caustic soda. Roughly half of this segment’s sales are to the domestic mining industry, while the pulp and paper industry accounts for another third.

By the end of 2012, the MLP will complete the construction of a 10th sour-gas processing facility at HollyFrontier Corp’s (NYSE: HFC) refining complex in Tulsa.

Management expects the MLP’s supply and logistics operating segment to generate much of the firm’s near-term distribution growth. In 2011, Genesis Energy purchased Florida Marine’s oil barge transportation service for $141 million and announced plans to expand its trucking fleet by 40 percent.

These moves, in conjunction with plans to build an oil storage terminal in the heart of the Eagle Ford Shale and the acquisition of a 90 percent interest in a refinery and pipeline in the Niobrara Shale, should enable Genesis Energy to grow its cash flow considerably in the coming years. All of these moves address rising production in oil-rich plays that lack sufficient takeaway capacity.

The MLP has no debt maturities until its $1 billion credit agreement comes up for renewal on July 25, 2017.

Genesis Energy LP is a buy below 30 in the Personal Finance Income Portfolio.