Commodities have dramatically outperformed the broader market so far in 2014. The iPath DJ-UBS Commodity Index Total Return ETN (NYSE: DJP) has risen roughly 10% this year, while the S&P 500 is up just over 1%.

But not all commodities have kept pace. Coal prices have suffered from the fracking boom, as natural gas inventories rose and prices fell.

Market Vectors Coal ETF (NYSE: KOL) is down 9% in the past year. And coal producer Walter Energy (NYSE: WLT) has fared much worse, declining roughly 60% in the past 52 weeks.

Yet, the death of coal has been greatly exaggerated, as it still accounts for the majority of electrical power generated in the United States. (My colleague Dave Goodboy recently took a look at the fuel’s near-term prospects.) And while coal as a commodity isn’t getting much love from investors at the moment, we can use an options strategy to generate an attractive level of income or buy shares of this beaten-down stock at a major discount.

As you can see on the one-year chart, WLT has dropped from $20 a share to new lows near $7.

#-ad_banner-#If you are comfortable holding on to this inexpensive stock for a potential recovery, then selling puts could allow you to collect income while you wait to get into WLT at a 21% discount.

Cash-Secured Put-Selling Strategy
While the typical investor might use a limit order to buy a stock or exchange-traded fund at a designated price or lower, the options trader can do one better by selling a cash-secured put option.

This strategy has the same mathematical risk profile as a covered call. When selling puts, there is an obligation to buy the stock at the option’s strike price if it is assigned, allowing you to get into the stock at a discount. In fact, the true entry cost basis is even lower with the subtraction of the premium you earned from selling the puts.

And if the stock is not below the strike price at expiration, then the premium received is all profit. In other words, you’re getting paid not to own the stock.

There are two rules traders must follow to be successful at selling puts.

Rule 1: Sell put options only on stocks you want to own.

The intention of the put selling strategy is to be assigned the stock as a long-term investment. Each option contract represents 100 shares, so make sure you have the funds in your account to buy the stock at the option’s strike price if a sell-off occurs. Paying in full ensures that no additional money is needed to hold the stock for potentially many months or even years until a price recovery.

Rule 2: Sell either of the front two option expiration months to take advantage of time decay.

Collect premium each month from selling puts until you are assigned shares at a cost-reduced basis. Every month that you keep the premium is money subtracted from your entry price.

Action to Take –> Sell to open WLT May 6 Puts at $0.25 or better. (Be sure to select the options expiring May 17, and use a limit order to get the desired level of income.)

This cash-secured put sale would assign shares at $5.75 ($6 strike minus $0.25 premium), which is about 21% below WLT’s current price and significantly below the stock’s 52-week lows, costing you $575 per option sold. If the put option expires worthless, you keep the $25 premium, earning a potential 4.3% return in 25 days.

Remember, you should only sell this put option if you want to own WLT at a discount to the current price. 

If you are assigned the shares, a June covered call  can be sold against the stock to lower your cost basis even further. If WLT does not fall below the strike price before expiration, then you keep the premium you collected, essentially getting paid not to buy the stock.

This article was originally published at ProfitableTrading.com: 
Earn 4.3% in 25 Days or Buy This $7 Stock at a 21% Discount

P.S. Using a similar options strategy, my colleague Michael Vodicka has developed a technique to multiply the income that investors earn from some of the world’s most reliable dividend payers. And you don’t have to be a sophisticated trader to use it. Click here to learn more.