By Robert Hauver

It’s been a rainy April for the market thus far, with the S&P down almost -3.00% through 4/19/12. Being  optimistic, we went searching for dividend paying stocks that are bucking the new market pullback.  We found 2 contenders, Caterpillar, (CAT), and Home Depot, (HD), that have held their own in this month’s market decline, and have also done well in recent rallies:

HD beat CAT in the Nov. 2011 pullback, and has also had stronger share performance year to date and during this month’s decline.

Valuations & Earnings Growth: CAT derives a lot of its profits from overseas, vs. Home Depot’s mostly domestic focus on the US home market. Subsequently, CAT has had stronger earnings growth in its most recent quarter and fiscal year, as the hobbled US consumer slowly picks up spending, and the home market remains weak. Although it’s up over 18% this year, CAT still looks more undervalued on a PEG basis than HD.

We’ll find out if CAT’s current EPS projections hold, when it reports earnings, on its upcoming April 25th morning conference call next week. (Judging by how far off analysts have been in their CAT estimates in recent quarters, it should be an interesting report.)

Dividends: Although CAT and HD aren’t high dividend stocks, both firms have a 5-year dividend growth rate that’s above their industry avgs.: CAT’s is 9.62%, and HD’s is 9.03%. CAT’s dividend payout ratio is more conservative than its industry avgs., while HD’s is much higher than its industry’s low avg. of 26.4%:

Covered Calls: Combining covered call options with dividend stocks is a powerful way to create much more immediate income than many stocks’ dividends offer over 1 – 3 quarters.  The increase in income is particularly high in a stock like CAT, which has high options yields that dwarf its dividend yield.  The tradeoff is that you may forgo potential future price gains, in return for being paid a call option premium now.  CAT has a higher beta and more volatility than HD, which gives it higher options yields.

In this trade, CAT’s August $110.00 call options pay well over 12 times its $.46 quarterly dividend.

If CAT is above $110.00 at or near expiration in August, your shares will be sold/assigned for $110.00, no matter how much higher CAT rises.  You’ll receive an additional $2.64/share in price gain, for an additional assigned yield of 7.54% annualized, and the total potential assigned yield is 25.86%. ($110.00 strike price – $107.36 stock cost = $2.64/share.)

How does this compare to just buying CAT outright at $107.36? Since you received a call premium of $5.95, at a strike price of $110.00, your maximum price point potential is $115.95.  If CAT doesn’t go as high as $115.95 during this 4-month term, you’d be ahead by selling this covered call.

(Each option contract corresponds to 100 shares of the underlying stock.)

The 3 income streams in this covered call trade are, (for 1oo shares of stock bought and 1 call option sold):

1. Call premium of $5.95/share, (paid within 3 days of the trade): $595.00

2. Quarterly dividend of $.46/share, (paid in August, ex-dividend date in July): $46.00

3. Potential assigned price gain of $2.64/share, if CAT is above $110.00 at or near expiration: $264.00

(You can see more details for over 30 other high options yields trades in our Covered Calls Table.)

Technical Data: CAT and HD have been two of the best stocks to buy for price gains over the past year:

As the table above shows, both of these stocks are quite close to their 52-week highs, which leads us to another, more conservative options strategy – selling puts.

Cash Secured Puts: By selling cash secured puts below a stock’s current price, you’ll achieve a lower break-even price, and also get paid within 3 days of making the put sale. However, you won’t qualify for any dividends, but, as you can see, the put options listed below pay out over 6 to 14 times what these quarterly dividends pay.

For every put option that you sell, your broker will secure enough cash in your account to purchase 100 shares of the underlyng stock, at whatever the put option’s strike price is, hence the name “cash secured puts”. In the CAT put option trade below, the broker would hold $10,500.00, (100 times the $105.00 strike price).

There are more details on these and over 30 other high yield Cash Secured Puts trades in our Cash Secured Puts Table.)

Financials: Both firms’ metrics are far above their industry avgs, except for CAT’s higher debt load. However, CAT has an interest coverage ratio of 6.4.

Disclosure: Author is short Caterpillar put options.