Been meaning to get to this, but the volatility in the markets has had me a little distracted……In this weekend’s edition of Barron’s, Steve Sears, Author of the Striking Price column relays a strategy that is designed to take in yield on already high dividend paying stocks…..
If you don’t own dividend-paying stocks, you should. By some studies, dividends account for 45% of historic stock gains. If you own dividend-paying stocks, buying more will not hurt you, and will very likely help.
But the key question is discerning how to most effectively buy these shares, as prices are well bid because so many people want to benefit from steady payouts. Michael Schwartz, Oppenheimer & Co.’s chief options strategist, is telling clients that they can overcome that hurdle by selling puts on issues that pay high dividends. This strategy positions investors to buy stocks at a discount.
Consider AT&T (ticker: T) and Verizon (VZ). Their dividend yields are 5.5% and 5.3%, respectively. Schwartz likes selling put options that are slightly out-of-the-money—that is, the strike prices are just below the stock’s market price—to maximize the options premiums. He also chose those two because he is happy to buy them, should they tick lower.
WORKS FOR VERIZON. With its shares at $36.40, Schwartz likes selling the January $36 put that expires in 2012. The put recently traded at $2.87. If the stock advances, and never falls below $36, investors again hold onto the premium, which serves as the special dividend. The premium also represents an almost 9% return if the option expires without being exercised. But should Verizon slip below $36, investors are obligated to buy the stock. The purchase price is similarly discounted by the amount received for selling the put. Another benefit of the cash-secured put strategy is that the money received for selling the options reduces the stock’s purchase price, which increases the dividend yield of each stock.
“It’s a win-win,” Schwartz says. “You earn 9% if the puts expire or you enhance the stock yield if the shares are put to you.”
I think this makes a lot of sense for individuals who do alot of research and make the decision that they would actually like to own the underlying stock if it was put to them.
I would consider a slightly different strategy in a name like VZ that pays a 5% dividend. If you arrived at the conclusion that VZ is a stock that you want to own for fundamental reasons and the dividend either serves as a nice cushion to the downside or an added bonus to the upside, I would buy the stock and sell strangles against it…..
For instance, if you bought VZ at 36.27 and then sold the Jan12 32/39 strangle at 2.00 then you could benefit from stock appreciation, the dividend, add increased yield, and create a downside cushion…..the biggest risk is that you could get put more stock at 32 (less the 2.00 cushion and the almost 1.00 dividend over 2 qtrs)…..lets break this strategy down and look at the potential risks and rewards……
LONG VZ at $36.27 and Sell the Jan12 32/39 strangle at 2.00
-Sell 1 Jan12 39 Call at .80 (28^ option)
-Sell 1 Jan12 32 Put at 1.20 (29^ option)
Break-Even on Jan12 Expiration:
Upside:
-Stock btwn 36.27 and 39 enjoy gains of the long stock (up to 2.73) and take in the 2.00 in premium…
-above 39, your long stock is called away at 39, but you take in 2.00 in premium, so you have effectively sold it at 41.97 (up 15.7% including the quarterly dividend of .4875 2 times)……
Downside:
-stock btwn 36.27 and 32 you have losses in your long stock of up to 4.27, less the 2.00 in premium that you receive for selling the strangle, and less the quarterly dividend of .4875 (2x)……
-stock below 32.00 you are put more stock effectively at 29.025, down almost 20% (32 less 2.00 in premium for strangle sale and .975 in dividends).
I would also add that you want to be tactical about this sort of thing and try to buy the stock when it is coming in and sell the options when implied volatility is elevated, this way you will get the most bang for your buck and increase your adds of success……