There is a strategy that I would like to discuss that may sound very complicated and potentially have you stop reading this article, but resist that and stick with me because it may be a strategy that could more than double the yield on your dividend paying stocks.
First off I’m not recommending the purchase or sale of any particular stocks, but I will speak about AT&T stock for exemplary purposes only. Many dividend investors view AT&T as a dividend play not growth, so let’s say you want to make a $25,000 investment in AT&T stock for the dividends which is roughly $1.92 per share for the year. But as you know with dividends on common stock, this is not guaranteed but voted on by the Board of Directors, however AT&T has had a consistent dividend.
So, let’s buy 300 shares of AT&T common stock today at about $38.50 a share that will cost us approximately $11,550. So that leaves us about $13,450 left over in cash which really doesn’t pay anything for interest, or does it? What I want to do is to go into the options market one year from now and sell three put option contracts which will represent 300 shares of AT&T, for that I will collect $2.62 per share in premium or $786 total. If AT&T stock trades below $37.50 per share at expiration, the AT&T shares will be put to me at 37.50 but I have collected $2.62 per share so my breakeven is $34.88. If AT&T stock is trading above $37.50 I just keep the premium and do not buy the stock. This would represent a 6.5% gain just by having sold three options contracts and collected the revenue from the premium.
We have a 6.5% gain on that portion of the trade, but I did buy 300 shares of AT&T for $38.50 a share that I’ve spent $11,550 for the shares and the stated dividend is $1.92 per share times 300 or $576 just for owning the stock. However, I did tell you this was “dividends on steroids”, so what I am going to do is sell three covered call options contracts representing the 300 shares that I purchased and I will collect $1.84 per share in option premium or $552 for a $40 strike price expiring next year at this time. Someone else has paid me $552 for the option to buy 300 shares of AT&T stock at $40 per share. If AT&T stock is trading above 40 a share, my breakeven is $41.84, strike plus premium collected. So, if the stock is not called away I would make 9.1% return if the stock was called away I would make 11.2% return on the 300 shares that I bought for $38.50 per share.
As I said before this may sound complicated, but don’t let that stop you from looking at the strategy that is commonly referred to as a buy/write strategy. Selling the cash covered puts was just to demonstrate that it can be done, however many just may want to buy 600 shares of AT&T stock and apply this strategy and sell six covered calls.
There is risk involved that must be understood and mitigated, but this strategy is only one of many portfolio management techniques that may or may not be appropriate for you. If you’d like more information on these strategies just call or email me.
Mark Patterson is Chief investment officer with MHP Asset Management and can be reached at (603) 447-1979 or mark@mhp-asset.com.
