In the first two parts of this series, we identified 2009's top 5 dividend stocks, based on total cash payouts to investors. We also identified a conservative strategy that will protect your dividend yields against a market pullback.
In this article, we'll discuss a strategy through which you can buy a stock at a discount to its current price, or, at least earn a nice yield by trying to.
The 5 stocks we listed were:
1. Royal Dutch Shell (RDS-A, RDS-B) - Pays $3.20/share, yielding 6.4%
2. AT&T (T) - Pays $1.64/share, currently yielding 6.7%.
3. General Electric (GE) GE's $.82/share 2009 payout currently equals a 6.1% yield. (The payout will decrease to $.10/share per quarter in the 3rd quarter of 2009, so the remaining payout/share for the balance of 2009 will be $.51, a yield of 3.8%, or 5.7% annualized).
4. Exxon Mobil (XOM) The company's annual dividend rate is $1.60/ share, for a 2.3% current yield.
5. Chevron Corp. (CVX), has an annual dividend/share of $2.60, which equals a dividend yield of 3.9% at the current price.
If you want to buy a stock, but you feel that the current price is too high, you have 2 alternatives:
First: You can try to wait out the market, if you're convinced of an imminent downturn and a cheaper price.
OR
Second: You can use the conservative option strategy of selling puts, to accumulate shares at a lower price.
As with selling covered calls, selling puts usually requires more initial capital than just buying an option outright, since brokers will require that you reserve up to 100% of the underlying shares value. (The % amount of required cash reserve varies from broker to broker).
Important note: Each put contract is tied to 100 shares of the underlying stock.
We'll use AT&T, (T), in our example of this strategy.
T closed today at $24.59. In T's JULY option table, there's a $24 put, (.TSF), that's selling for $1.10.
This $1.10 put premium compares favorably to T's July $.41/share dividend, so it would still make sense to sell this put, instead of just buying T outright at $24.59 and waiting for the $.41 July dividend.
Just to keep it simple, assume you sold one JULY $24 put (.TSF) for $1.10, and that your broker had you reserve 100% of the underlying value.
This trade breaks down as follows:
Cash Reserve: $2400 (100 shares x $24 strike price)
Revenue: $110.00 (1 put contract sold at $1.10 x 100 shares)
Yield: 4.58% ($110/$2400) Annualized Yield: 27.4%
Breakeven Price: $22.90 ($24 minus $1.10 put premium)
Discount to Current Price: 6.87% ($24.59 - $22.90)/($24.59)
Dividend Yield at Breakeven Price: 7.16% ($1.64/$22.90)
When the July expiration date comes, one of two events will occur:
1. If T hasn't declined to or past the $22.90 breakeven, your cash reserve will be released, and you simply walk away with a 27.4% annualized gain.
OR
2. If T does decline to or past the $22.90 breakeven, 100 shares will be assigned/sold to you at $24.00 strike price. However, your true net cost is $22.90, ($24 minus $1.10 put premium).
Sometimes shares may be assigned before expiration date, around the ex-dividend date, but this doesn't happen a majority of the time.
The keys to selling puts are:
1. Deciding at what price you'd be comfortable owning the underlying shares. This, of course, requires due diligence.
2. Deciding how conservative or aggressive you want to be. It's helpful to look at the 1 and 2-year lows for a stock, before selling puts, to see how various strike prices compare to the stock's historical trading range.
In the past 6- 7 months, selling puts at strike prices below or close to a stock's 52-week low has worked well for many traders. If you want to be more conservative, then sell at a lower strike price, further out of the money. While this approach will net you a lower premium, it might fit your risk profile better than selling at or close to the money.
Concerning the concept that selling puts allows you to buy a stock at a discount, some would argue that, if you had done nothing and just waited for a market downturn, you could have bought the stock at the lower price anyway.
While this is true, it's also true that by selling puts, you're giving yourself the opportunity to either earn a high yield on the put premium, if the stock's price rises; or, to buy the stock at a predetermined, lower price of your choice, in the future, if it falls.
This conservative bullish strategy usually works best in a rising market, and it will give you some participation in a stock's upward movement, and some downside protection in case of a market decline.
In this article, we'll discuss a strategy through which you can buy a stock at a discount to its current price, or, at least earn a nice yield by trying to.
The 5 stocks we listed were:
1. Royal Dutch Shell (RDS-A, RDS-B) - Pays $3.20/share, yielding 6.4%
2. AT&T (T) - Pays $1.64/share, currently yielding 6.7%.
3. General Electric (GE) GE's $.82/share 2009 payout currently equals a 6.1% yield. (The payout will decrease to $.10/share per quarter in the 3rd quarter of 2009, so the remaining payout/share for the balance of 2009 will be $.51, a yield of 3.8%, or 5.7% annualized).
4. Exxon Mobil (XOM) The company's annual dividend rate is $1.60/ share, for a 2.3% current yield.
5. Chevron Corp. (CVX), has an annual dividend/share of $2.60, which equals a dividend yield of 3.9% at the current price.
If you want to buy a stock, but you feel that the current price is too high, you have 2 alternatives:
First: You can try to wait out the market, if you're convinced of an imminent downturn and a cheaper price.
OR
Second: You can use the conservative option strategy of selling puts, to accumulate shares at a lower price.
As with selling covered calls, selling puts usually requires more initial capital than just buying an option outright, since brokers will require that you reserve up to 100% of the underlying shares value. (The % amount of required cash reserve varies from broker to broker).
Important note: Each put contract is tied to 100 shares of the underlying stock.
We'll use AT&T, (T), in our example of this strategy.
T closed today at $24.59. In T's JULY option table, there's a $24 put, (.TSF), that's selling for $1.10.
This $1.10 put premium compares favorably to T's July $.41/share dividend, so it would still make sense to sell this put, instead of just buying T outright at $24.59 and waiting for the $.41 July dividend.
Just to keep it simple, assume you sold one JULY $24 put (.TSF) for $1.10, and that your broker had you reserve 100% of the underlying value.
This trade breaks down as follows:
Cash Reserve: $2400 (100 shares x $24 strike price)
Revenue: $110.00 (1 put contract sold at $1.10 x 100 shares)
Yield: 4.58% ($110/$2400) Annualized Yield: 27.4%
Breakeven Price: $22.90 ($24 minus $1.10 put premium)
Discount to Current Price: 6.87% ($24.59 - $22.90)/($24.59)
Dividend Yield at Breakeven Price: 7.16% ($1.64/$22.90)
When the July expiration date comes, one of two events will occur:
1. If T hasn't declined to or past the $22.90 breakeven, your cash reserve will be released, and you simply walk away with a 27.4% annualized gain.
OR
2. If T does decline to or past the $22.90 breakeven, 100 shares will be assigned/sold to you at $24.00 strike price. However, your true net cost is $22.90, ($24 minus $1.10 put premium).
Sometimes shares may be assigned before expiration date, around the ex-dividend date, but this doesn't happen a majority of the time.
The keys to selling puts are:
1. Deciding at what price you'd be comfortable owning the underlying shares. This, of course, requires due diligence.
2. Deciding how conservative or aggressive you want to be. It's helpful to look at the 1 and 2-year lows for a stock, before selling puts, to see how various strike prices compare to the stock's historical trading range.
In the past 6- 7 months, selling puts at strike prices below or close to a stock's 52-week low has worked well for many traders. If you want to be more conservative, then sell at a lower strike price, further out of the money. While this approach will net you a lower premium, it might fit your risk profile better than selling at or close to the money.
Concerning the concept that selling puts allows you to buy a stock at a discount, some would argue that, if you had done nothing and just waited for a market downturn, you could have bought the stock at the lower price anyway.
While this is true, it's also true that by selling puts, you're giving yourself the opportunity to either earn a high yield on the put premium, if the stock's price rises; or, to buy the stock at a predetermined, lower price of your choice, in the future, if it falls.
This conservative bullish strategy usually works best in a rising market, and it will give you some participation in a stock's upward movement, and some downside protection in case of a market decline.
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