You know the drill on bond yields, there is little to none. In this environment, investors have crowded into equities that have better yields than their company’s debt, like utilities, pharma and telcos. From time to time we have taken long positions in stocks or etfs for this very reason, a fat dividend yield (see XLU, PFE & VZ of late). In the case of PFE and VZ we have looked to add to the dividend yield by overwriting the stock (selling an out of the money call), thus capping the potential upside, but adding a small buffer to the downside, while looking to potentially double the dividend yield on an annualized basis. It’s very important to note that as investors seek yield in stock’s deemed to be defensive, there is certainly risk to owning a stock that falls in this camp, because they become crowded longs.
For those who are currently long and strong a stock like Verizon (VZ), we think the stock sets up for a decent near term opportunity to super-size its existing 4.25% annual dividend yield by not only overwriting, but by also underwriting, selling a strangle, which against long stock means selling in this example, an out of the money put and call of the same expiration:
Vs 100 shares of VZ long at $52.75, sell the Aug 48 / 55 strangle at 85 cents
- Sell to open 1 Aug 48 put at 45 cents
- Sell to open 1 Aug 55 calls at 40 cents
Break-even on August expiration:
-Profits of the stock up to $55, or $2.25, stock called away above $55, but have received 85 cents in premium, or 1.6% over the two months between now and August expiration, or about 10% annualized. Offering a call away level of $55.85, up 6% from current levels, above the prior highs.
-Losses of the stock below $52.75, but really $51.90 as the premium received for the straddle sale serves as a buffer to the downside. the worst case scenario the stock is down below the short put strike of $48 and you would be put 100 shares of stock there, down 9% from current levels.
Rationale: As for choosing strikes, since the stock broke out to new 52 week highs back in late January, VZ has been range bound between $48 and $54, which should serve as a near term support resistance range, with the stock’s 200 day moving average being back down at $48, and the call-away level above the prior 52 week high just above $54:
The entry on the stock today isn’t ideal as it’s up 1.5% in a down market based on investors chasing this type of yield. But we very much like the idea of supercharging these plays. Obviously the put sale means possibly being put the stock on a significant pullback but as you can see in today’s price action, investors are favoring these stocks even on days when the rest of the the market is getting hit.