Monthly Archives: July 2011

Turning Steel Into Gold: How To Quadruple Your Yield On Dividend Stocks

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By Robert Hauver

Want to turn steel into gold?  Here are 4 undervalued dividend paying stocks from the Steel & Iron industry, with strong recent earnings growth, conservative debt loads, low 12-month PEG’s, which you can earn double-digit annualized yields on, via selling Covered Calls and Cash Secured Puts:

NUE-MT-DIVS

All 4 stocks pay quarterly dividends, and 3 of them sport a very conservative dividend payout ratio.

Selling Cash Secured Puts: These 4 dividend stocks all have pretty high options yields, which you can take advantage of, and achieve a break-even price near their 52-week lows on 3 out of 4 of them.

These put option premiums pay you over 4 times up to 8 times what the dividend premiums pay during this period:

NUE-T PUTS

You can find more details on these and other put options sales in our Cash Secured Puts Table. There’s also more info on the mechanics of selling puts at this article link.

Selling Covered Calls: Unlike selling cash secured put options, selling covered call options allows you to potentially participate in some price gains, if you sell calls at a strike price above the current price of the underlying shares. If the underlying shares are assigned/sold away from you, you’ll gain the difference in price between your cost/share and the strike price you sold calls at.  For example, the potential price gain for WOR is the highest one below, $1.54, ($22.50 strike minus $20.96 share price).

Selling covered calls also gives you an immediate lucrative option income stream, in addition to the dividends you’d collect. These call options pay 4 to 7 times what the dividends pay, which turns a moderate dividend yield of 2.5% to 3%+, into a double-digit annualized yield.

NUE-MT-CALLS

You can find more details on these and other put options sales in our Covered Calls Table. Our July 22nd article offers more call options selling mechanics as well.

Valuations:

NUE-MT-PEG

Financials: Small cap WOR definitely wins in the mgt. efficiency, interest coverage, and operating margin comps, and has been favored by investors for it with the only price gains ytd, (See the performance table below).

NUE-MT-ROE

Performance/Technical Data: With Relative Strengths of around 40, all 4 stocks are on the edge of oversold territory. Only WOR has made positive price gains year to date.

NUE-MT-PERF

Disclosure: No positions at this time.

Disclaimer: This article is for informational purposes only and isn’t intended as individual investment advice.

How To Defend Your Dividend Stocks With Covered Calls

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By Robert Hauver

With the recent choppy market action, you may be wondering how best to protect your gains, without abandoning your income-producing dividend paying stocks. Selling Covered Calls offers you another income stream from your stocks, in the form of option premiums.  This week we’ll walk through covered call trades for three dividend stocks from our High Dividend Stocks By Sector Tables.  Two of these stocks, ABT and PG, are Dividend Aristocrats:

ABT-GE-PG-DIVS

Financials:

ABT-GE-PG-ROE

Covered Calls (Expiring Jan. 21, 2012):

ABT-GE-PG-CALLS

(We’ll use a one contract sale in our examples, for simplicity’s sake. Each call options contract corresponds to 100 shares of the underlying stock.)

ABT covered call trade:

1. Buy 100 shares of ABT at $52.40.

2. ABT closed at $52.40, and you’d “sell to open” a Jan. 2012 $52.50 call option, “at the money”, i.e., close to the stock’s current price.

You receive a premium of $2.17/share, ($217.00 per option contract), more than twice ABT’s dividend during this 6-month period.

3.During the next 6 months, you’d also collect 2 quarterly dividends, for a total of $96.00.

So you’ve collected $96.00 in dividends, plus $217.00 in call option premiums, thereby turning a 3.69% dividend yield into a 12.05% static yield, 0ver 3x the dividend yield.

(Static yield refers to a scenario in which your stock doesn’t rise enough to be assigned/sold away from you at expiration time. In general, if the underlying doesn’t rise to or past the  approx. combination of the strike price and the call premium, your shares won’t be called away. However, other factors, such as an upcoming ex-dividend date, can sometimes make it worthwhile for a call buyer to exercise the option to buy the shares.)

4. Two Possible Expiration Scenarios:

Static Yield – You keep your shares, for a static yield of 12.05%.

Assigned Yield – Your shares are assigned/sold at the $52.50 strike price, and you receive an additional $10.00, (the $.10 difference between the $52.40/share cost and the $52.50 strike price times 100 shares).  Your total annualized gain is 12.43%

Note: We used the $52.40 price to illustrate the yields in this trade. If you already owned ABT, just use your cost basis to calculate your yields and gains.

Advantages of selling Covered Calls:

1. Quicker Income/Better Cash Flow: You receive the option $ within 3 days of selling, often the same day, as opposed to waiting for quarterly dividends.

2. Lower Your Risk: The call option $ you receive also lowers your break-even cost, thereby giving you a stronger defense vs. market downturns.

3. Tax Deferral: If the call expires, or isn’t exercised until 2012, you don’t have to pay taxes on it until April 2013.

Disadvantage:

1. When you sell a call, you’re obligated to potentially have to sell your underlying shares at a specific strike price by the expiration date.  Your upside price gain potential is limited to the combo of the strike price plus the option $ you received. In the ABT example, it’s $54.77: the strike of $52.50, plus the $2.17 option premium, plus the potential $.10 if the shares are assigned/sold.

The judgment you need to make is whether or not you think your shares will rise considerably past this point, or if you’d prefer to get paid now, and gain more risk protection if the market falls.

GE covered call trade:

GE-Calls

(You can find more details on these 3 trades and other Covered Calls trades in our Covered Calls Table.)

This GE trade has the highest static and potential assigned yields of these 3 trades, due to its call bid premium of $1.14 yielding 12,23%.  GE decreased its dividend from $.31/quarter to only $.10 during 2009, but has brought it back to $.15/quarter in 2011.

Another advantage of selling covered calls is that, unlike dividends, the company can’t control your payout. Once you’ve sold a call, that $ is yours to keep, unlike future dividends, which may be cut at any time by the company, which happened quite often in the downturn.  Fortunately, firms are back on the track to restoring and increasing their dividends, so that negative trend has been reversed, for the time being.

This trade also expires in Jan. 2012, roughly 6 months.

1. Buy 100 shares of GE at $18.79.

2. Sell the Jan. 2012 $19.00 call for $1.14/share, and receive $114.00 within 3 days.

3. Collect $30.00 in dividends prior to expiration.

4. Expiration outcomes: The same two possible scenarios -

Assigned: GE rises approx. to or above $20.14, (the combo of the $19 strike price plus the $1.14 call bid), your shares get sold for $19.00, and you’ll receive an additional $21.00, (100 shares time $.21/share; the difference between $18.79 cost and the $19.00 strike). You’ve made 17.71% annualized, 5.5 times the original 3.22% dividend yield.

Static: GE doesn’t rise to approx. to or above $20.14, and your shares aren’t assigned/sold away.  You’ve made 15.45% annualized, nearly 5 times the original dividend yield.

(The details for the PG trade are listed in our Covered Calls Table.)

Valuations:

ABT-GE-PG-PEG

Disclosure: Author is long GE shares, long PG shares, and short PG calls.

Disclaimer: This article is intended for informational purposes only.

How To Buy Dividend Stocks Below The Market

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By Robert Hauver

Hey income investors, what would you say if someone told you that you could consistently buy certain dividend stocks below the market, get paid now to do it, earn more $ than the stocks’ dividends paid, and defer your taxes on this money for a year?

Sounds like a pretty good deal, right? Well, it is, with a couple caveats, which are often negligible.

We’re talking about selling cash secured put options, a conservative strategy that may seem counter-intuitive at first, but can be quite a lucrative cash cow once you understand how it works.

Here are 2 examples, using dividend paying stocks from our High Dividend Stocks By Sectors Tables:

Selling “out of the money” cash secured puts for Southern Copper (SCCO):

1. Instead of buying SCCO outright, at $35.43, go to SCCO’s options chain, and find the January 2012 option table.

SCCO-SchwabPut

(Source: Schwab Streetsmart)

SCCO was selling at $35.43, so I picked the $35.00 strike price, just under the stock’s current price, i.e. “out of the money”.

The current bid for the $35.00 Jan. 2012 put was $3.70, meaning that a put “buyer” is willing to pay you $370.00 for each Jan. 2012 SCCO $35.00 put that you sell.

This is a 10.57% yield for a 190-day term, or approx. 20.31% annualized:

SCCO-PutExmple

(Note: We listed the $1.12 in dividends for comparison to the option $ only. Put sellers don’t receive dividends. However, in this case, the option $ you’d receive is over 3 times the dividend $.)

You’ll find more details on this and other put sales in our Cash Secured Puts Table.

Step-by-step trade details. (We’ll only sell one put option, to keep it simple):

1. “Sell to open” one Jan. 2012 $35.00 put option for SCCO: (symbol SCCO 01/21/2012) This sale obligates you to buy, (have “put” to you), 100 shares of SCCO at $35.00 until the Jan. 21, 2012 expiration date, which may or may not happen. (More info below).

2. Your broker reserves/freezes $3500.00 in your account: Each option contract corresponds to 100 shares of the underlying stock. Thus, 100 shares of SCCO at $35.00 equals $3500.00.

3. Your broker credits your account for $370.00 within 3 days. (Schwab usually does this immediately.)

Possible outcomes at the Jan. 2012 expiration:

1. SCCO’s stock price stays the same or rises: You don’t end up having to buy the 100 SCCO shares. Your $370.00 profit is a 2012 short term capital gain, with taxes due by April 15, 2013.

2. SCCO’s stock price falls by less than approx. $3.70, (i.e. it stays above $31.30, your breakeven price): Same result as #1; your $370.00 profit is taxable in 2013.

3. SCCO’s stock price falls to or below $31.30, your breakeven price: You are assigned/sold 100 shares at $35.00, BUT, your actual net price is $31.30, (the $35.00 strike price, minus the $3.70 option premium $ you received).

There’s an interesting tax break you get when this happens: You don’t have to pay a short term capital gains tax on the $370.00 you received. Instead, the IRS says that you must use the $370.00 to lower your tax basis on the 100 shares you had to buy.

So, if you end up holding your 100 shares of SCCO longer than 12 months, (past Jan. 21 2013), your short term capital gain is then treated as a long term cap. gain, whenever you sell.  In other words, your taxes on the $370.00 are deferred until you sell the underlying 100 SCCO shares.

That’s a pretty good tax deal – you get the use of the $370.00 now, but you don’t have to pay taxes on it until April 2013, providing it expires or is assigned in 2012. This is one of the reasons why Warren Buffet has made some massive put sales out into the future – he gets paid the put premiums up front, gaining the use of the $ now, while simultaneously delaying paying taxes on it until the year after they expire.

Example 2: Selling “in the money” Cash Secured Puts for Conoco Philips (COP):

You’ve probably heard about the proposed breakup of Conoco into 2 divisions that was announced Thursday, which analysts are valuing north of $90/share.

If you want to get in on this action, but you don’t want the risk of buying COP outright, take a look at this next trade.

COP was selling at $76.38, but if you want to be aggressive, you could sell the Jan. 2012 $80.00 puts, and still have a $71.70 breakeven, well below the current price:

COP-Schwab

Again, the put option premium outstrips the dividend, this time by over 6 times:

COP-putsArticle

You’ll find more details on this and other put sales in our Cash Secured Puts Table.

Notes:

1. Some traders feel that it’s not worthwhile selling puts, because the put premiums you receive may be less than the upside price gains, if a stock takes off. While this can be true, selling cash secured put options gives you the benefit of instant cash participation now, vs. possible future higher gains.  So, you take your put premium cash now and re-deploy it elsewhere, vs. having all of the money tied up in buying the stock outright, and waiting for dividends.

2. Other traders say that, if the stock goes down, you could have bought it for even less than your breakeven price from a put trade.  Since nobody knows the future, you have to decide if you’d like to get “paid to wait”, by collecting a put premium now, or hope that the stock does decline to your desired entry point.

3. What to do if the stock declines past your breakeven: Unlike just buying a stock, the put selling strategy also allows you to “retreat”, if the trade goes against you, by “buying to close” your sold puts, (closing out the position), and selling lower strike price puts, to recoup part or all of a loss. You can also sell further into the future, and get more $, since the time value normally is higher, the further out into the future that you sell.

4. You can often sell for more than the put bid price being offered. In the SCCO example, put bidders were offering $3.70, and put sellers were asking $4.20. Try selling at somewhere in the middle, or at least above the bid price, if there’s a wide spread. The relative amount of bidders and sellers also impacts the price you’ll get – there were 526 put sellers, vs. only 218 put bidders, so the balance is in the bidders’ favor in this example.

Disclosure: Author is short SCCO puts and COP puts.

Disclaimer: This article isn’t intended as individual or personal investment advice. Please do your own due diligence.

Diving For Dividends And Options- 4 Small Caps Selling For Less Than Book Value

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By Robert Hauver

With over 69% of stocks above their 50-day moving averages, it’s getting tougher to find bargains in this market, so we went looking for dividend paying stocks with Price/Book values under 1, and found four small caps, two of which are listed in our High Dividend Stocks By Sector Tables.  There are also some pretty high options yields available on 3 of these stocks, (details below).

FLY-NKA-NM-DIVS

All 4 firms have dividend yields above the current S&P average, have a conservative dividend payout ratio, and pay quarterly dividends.

FLY: Leases commercial aircraft, and changed its name from Babcock & Brown in 2007.  FLY owns a fleet of 60 aircraft that it leases under multi-year operating leases to 34 airlines in 23 countries.

NKA: Is the largest independent owner and operator of natural gas storage in North America, with strategically located assets in key natural gas producing and consuming regions.

MCS: Has 2 divisions: Marcus Theatres is the sixth largest theatre circuit in the U.S., with locations in major markets in the Midwest. Marcus Hotels and Resorts, owns and manages 18 hotels, resorts and other properties in nine states.

NM: Operates principally handymax and panamax bulk carriers, deploying owned, chartered and leased vessels. Also owns and operates the largest bulk terminal in Uruguay — one of the most successful and prominent operations of its kind in South America.

Valuations:

FLY-NKA-PEG

There’s a wide spread in the PEG values of these firms, which makes sense, given their 4 disparate industries. FLY’s near-term EPS growth prospects are the lowest in the group, whereas MCS, NKA and NM sport low near-term PEG ratios.

If the economic recovery strengthens, MCS’s theatres and resorts should benefit, whereas NM has a mix of short- and long-term chartered vessels, and has exposure to demand for basic materials, such iron ore, coal, grain, and fertilizer.

NKA’s website states, “The ability to store and retrieve natural gas adds an important dimension to reliability of gas service. Access to storage allows individual gas buyers to acquire low-cost supplies on the spot market during off-peak periods, such as the summer months, and to store the gas in locations near to end-users during periods of peak demand.” 

Financial Metrics:

FLY-NKA-ROE

Although it has the highest debt load, FLY has an interest coverage ratio of 1.6, and NM’s interest coverage is similar, at 1.8. NM’s ROE of 7.54%, although the lowest in this group, is a lot better than its peer average of -6.71%, a result of the drubbing that the shipping industry has taken in recent years.

Covered Calls:

Three of these stocks have options available, which will allow you to greatly increase their dividend yields, via selling covered calls.

The upside: You get paid the call option premium now, (within 3 days of selling calls), you receive up to 5 times the dividend amount in call premiums, and if the option expires or is assigned in 2012, you won’t have to pay taxes on the call options $ you received until 2013.

The downside: Your upside price gains are limited to the approx. threshold of the strike price + call option premium. For example, if you sell NKA $17.50 calls, you’re obligated to sell your NKA shares at $17.50, even if it goes much higher than that. In theory, you’re betting that it won’t go past $18.35, the combination of the $17.50 strike and the $.65 you received for selling the call option.  Also, if your shares are assigned/sold, this lowers your cost basis by the amount of call premium you received. If the call options expire worthless, the call premiums are taxed as a short term gain. You can find more details on these and other covered call trades in our Covered Calls Tables.

FLY-NKA-MCS-NM-CALLS

Cash Secured Puts: Selling cash secured put options is a more defensive way to profit from a stock that you’d like to own, but, whose price is currently too high for you to buy outright.  By selling at a strike price near or below the current share price, (“At the money” or “out of the money”), you’re often able to achieve an even lower break-even price. The same cash flow and tax advantages apply as with covered calls.  You can find more details on these and other covered call trades in our Cash Secured Puts Tables.

FLY-NKA-MCS-NM-PUTS

Technical/Performance Data:

FLY-NKA-PERF

All 4 stocks are below their 50-day avgs., having trended lower over the last quarter. FLY declined the least, having benefited from increasing institutional buying. FLY and NM both have much more room for more institutional ownership.

Disclosure: Author is long shares of FLY.

Disclaimer: This article is written for informational purposes only.

5 Undervalued Dow Dividend Stocks With Strong Growth & Double Digit Covered Calls

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By Robert Hauver

We’re halfway through 2011, with the Dow up 7.23%, and the S&P up 5.01% so far. Not bad, especially when you compare it to the first half of 2010, in which the Dow fell -6.3%, and the S&P was down -7.9%.  Of course, the second half of 2011 most likely won’t have the benefit of a massive QE2 $ injection, like 2010 had.  So, what do you do to lock in some gains on some undervalued dividend paying stocks?

Selling covered calls is one proven way to more than double your dividends, and also lower your downside risk.  This week, we found 5 Dow dividend stocks with low Price/Earnings Growth ratios, (PEG),  and double-digit covered call option yields.

BA-CAT-GE-DIVS

Although they don’t qualify for our High Dividend Stocks By Sectors Table, a majority of these firms’ dividend yields are above the current 2.39% S&P average, and they all have a conservative dividend payout ratio.  JPM has also indicated that it’s hoping to increase its dividend in the near future.

Valuations:

BA-CAT-GE-PEG

All 5 firms achieved EPS growth in the past fiscal year and quarter-over-quarter. They all also all look undervalued on a PEG basis for their next fiscal year. TRV lags behind the other firms big EPS growth figures, mainly because their Business Insurance segment’s underwriting results in 2010 deteriorated, largely due to a sharp increase in catastrophe losses. The combined loss and expense ratio increased to 91.3% in 2010, vs. 86.1% in 2009.

Share Performance/Technical Data:

BA-CAT-GE-PERF

TRV has outperformed the S&P year-to-date, but CAT and BA trounced it by nearly 3 times.  GE, still re-focusing its many segments, was just below the S&P’s performance, while JPM, as a part of the still-dreaded Financials sector, is actually negative through June 30, 2011.

JPM, TRV, and CAT are approaching the oversold, sub-40 Relative Strength Index threshold, whereas GE’s 51.69 RSI is neutral, and CAT’s 60.39 RSI is on the cusp of Overbought territory. All 5 stocks had good gains this week, and CAT has made 40% of its YTD gains this week.

Covered Calls – (Jan. 2012 Expiration):

Look at the disparity between the call option yields and the dividend yields for this 8-month term.

The call options pay over 3 to 7 times the amount of the dividends. There are also some additional potential price gains with these covered call trades, most notably with CAT, BA and TRV.

BA-CAT-GE-CALLS

You can find more details on these and other Covered Call trades in our Covered Calls Table.

Cash Secured Puts – (Jan. 2012 Expiration):

If you’re less bullish, you can take a more conservative stance, and still earn attractive options yields, via selling cash secured put options at a lower strike price than the current underlying stock price.

This will give you the added protection of a lower break-even price. (Note: The dividends are listed on this table for comparison only – put sellers don’t collect dividends.)

BA-CAT-GE-PUTS

You can find more details on these and other Cash Secured Put trades in our Cash Secured Puts Table.

Financial Metrics:

BA-GE-CAT-ROE

The Financial metrics are a mixed bag for this group, ranging from stellar mgt. efficiency ROE figures for BA and CAT to low ROI figures for GE and JPM, 2 firms which are still recovering from the impact of the recession.  Except for TRV, all these firms are leveraged, with high Debt/Equity ratios, but also appear to have reasonable interest coverage. (For what it’s worth, the aggregate Debt/Equity ratio for the S&P is only .69, but, of course, debt/equity varies by industry.)

Disclosure: Author is long GE, and short CAT puts & JPM puts.

Disclaimer: This article is written for informational purposes only.