TransAlta Signals a Technical Buy

This week I’m looking at TransAlta (TSE:TA) as a buying opportunity. Not only did TransAlta options make the most active list last week, an analysis of the price chart reveals a number of technical attributes supporting a continuation to the upside for the stock.

TransAlta is a non-regulated electricity generation and energy marketing company with businesses in Canada, the United States, and Australia. Their business includes the generation and wholesale trade of electricity and other energy-related commodities and derivatives.

TransAlta’s diversification of resource markets include:

• coal
• natural gas
• hydro
• wind
• geothermal

The Technicals

If you are not familiar with all of the technical observations above, the main consideration is that there has been a shift in the primary down trend that has been respected since the beginning of the year. In addition, prices are now holding above the near term average and momentum is building to the upside. For a longer term confirmation of a possible change in trend, investors can overlay a 200 day moving average. Prices closed above this long term trend indicator this past week.

TransAlta is yielding an attractive dividend. According to TransAlta Shareholder Information dividends are paid January, April and July and October. The payout to date has been $0.29/share, which represents an annual yield of 8% as of Friday, November 15th close of $14.50. With prices bouncing off historical lows and technicals suggesting a possible upswing, the timing might be right to consider buying shares. An investor who wishes to pick up the next dividend would need to own the shares before it goes ex-dividend which is November 27th for payout on January 1st, 2014.

The options market offers a strategy to help meet almost every objective. For example, an investor who is focused on enhancing yield could integrate the covered call strategy.

The below option chain reflects option premiums as of the close on November 15th. The last price of the June 2014, 17 strike call was $0.20.

While the covered call writer may be able to get a better fill based on the bid and ask spread, a passive investor focused on income may consider selling the June 17 strike call to bring in some additional cash flow.

By choosing the June 2014 expiration, the investor will be less transactional as the call expires in 213 days. This means that the investor will not have write new calls month after month and is less concerned about assignment as the strike is several dollars away from the current stock price. This allows for an appreciation in share value by 19% and brings in another 1.5% yield which would annualize to approximately 2.5%.

The investor now has the potential to increase the yield on the TransAlta shares by 10.5% while benefiting from an appreciation in share value. Over the time period, if the investor is concerned about short term risk, a protective put could be purchased to hedge the downside using a portion of the cash flow generated through dividends and call writing.

To potentially increase the return on the covered call portion, the investor may sell shorter term, closer to the money calls. The risk with this approach is the potential for assignment before the dividends are collected as well as the increased transaction costs do to the more active writing.