Volatile Vale SA (ADR) (VALE) Stock Is a Free-Income Magnet

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Brazilian iron ore producer Vale SA (ADR) (NYSE: VALE ) roughly doubled off the October lows, but it has since retraced the lion's share of it. For the past few days, VALE stock had been digging its way out with higher lows … but then it crashed 4.4% Wednesday.

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That's OK. I like what I see.

Fundamentally, VALE stock is cheap relative to its sector, at least on a price-to-earnings basis. The company also seems to retain more of its dollar. Add to that the fact that Vale pays a dividend, and I see the chance to create income from a fallen angel.

Don't mistake today's trade with upside enthusiasm, though. I am merely betting that the worst is over and that soon enough, this miner should find its footing.

I would classify this setup as a speculative trade in a conservative portfolio.

Click to Enlarge This is not a sure thing. I see several potential pitfalls. That's why I want to use options instead of buying the stock outright.

With options, I can leave room for error and mitigate the size of the risk. I fear Vale's high debt levels, for example. Even though Vale management has been deleveraging operations, the absolute debt levels are still too high for my comfort.

And regardless of what economist try to tell us, the globe is not growing as much as the consensus perceives.

Since the 2008 planetary crisis, much of the growth has been artificial. Central banks have gone overboard throwing money at the problem. The U.S. Federal Reserve is one of few who is trying to reverse the process. I fear for further threats to VALE if this causes a future recession.

Last, but certainly not least, is the presidential corruption scandal embroiling Brazil. The mere accusations have already given Brazilian stocks a haircut, and anything more concrete could really do some damage.

How to Trade VALE Stock

The Bet: Sell the Dec $7 put naked and collect 50 cents per contract. This is a bullish trade that needs shares to stay above the strike price. Otherwise, I will own the shares and would suffer losses below $6.50. The 15% price buffer gives this trade an 80% theoretical chance of success.

To further reduce the maximum risk, I can use credit put spreads instead.

The Spread: Sell the Dec $7/$6 credit put spread. I have about the same chances of success, and I still can yield 25%, but I also enjoy a much more limited risk profile. Or you could always try to buy VALE stock at $8.40 per share with no room for error and hope it rallies 25% … but hey, to each their own.

Selling options is risky business, so only bet what you're willing to lose.

Learn how to generate income from options here . Nicolas Chahine is the managing director of . As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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