The Top Dow Dividend Stocks For First Quarter 2012 Earnings

By Robert Hauver

25 of the 30 Dow Jones Industrials have reported 1st quarter 2012 earnings so far. 18 firms have reported positive growth, and 7 have reported negative growth, with the range running from Boeing, (BA), with 54% year-over-year 1st quarter growth, down to beleaguered Bank of America, (BAC), with -82%. These 2 Dow dividend stocks reported the best 1st quarter 2012 earnings growth year-over-year:

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

Author: Robert Hauver © 2012 Demar Marketing All Rights Reserved

These Dow Dividend Stocks Are Bucking The April Pullback

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:

CAT-HD-PERF

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.

CAT-HD-PEG

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.)

CAT-ANLYSTMISSES

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%:

CAT-HD-DIVS

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.

CAT-HD-CALLS

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:

CAT-HD-TECH

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.)

CAT-HD-PUTS

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.

CAT-HD-ROE

Disclosure: Author is short Caterpillar put options.

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

Author: Robert Hauver © 2012 Demar Marketing All Rights Reserved

Analysts Are Clueless About These Dow Dividend Stocks

By Robert Hauver

Earnings season is on a roll, and traders are playing the old “earnings estimates beats/misses” game, which often has tenuous ties to reality, at best, as analysts go from being over-excited to being overly pessimistic.  Here’s just how wrong analysts have been about Caterpillar over the last 4 quarters:

CAT-ANLYSTMISSES

Could it be that CAT is just a special case?  Not really – analysts were even more clueless about Boeing.  Can you just imagine, (I shudder to think), if you were to submit an estimate to your boss that was off by over -80%, and then followed up that brilliant piece of work with another estimate that was off by over -30%?   Do you think it might possibly prompt a reassignment or even a permanent vacation?  Not so on Wall St. – where being consistently and often egregiously wrong is OK.

Why is that?  Because it supports the trading excitement of “Earnings Beats & Misses”.  Just think about it, the market often bases its decisions on the estimates of a group of external people, who don’t have access to the daily, inside info of the stocks they’re supposed to be informing us about.  If this sounds like folly, it often is:

BA-ANLYSTMISS

Instead of just listening to analysts “pie in the sky” or “gloom and doom” predictions, try looking at what companies actually earned each quarter vs. a year ago:

BA-CAT-EPS GROWTH

We can also look at their quarterly Revenue Growth vs. a year ago:

BA-CAT-SALES

CAT has been one of the best stocks to buy in 2012 and in 2011 for price gains, but Boeing shares haven’t risen nearly as much. Here’s one reason why.  BA is forecasting lower 2012 earnings per share, of $4.05 to $4.25, vs. 2011’s $5.33 EPS, whereas CAT is forecasting continued strong growth. Even though BA has a record order backlog, unlike other companies, they can’t rush their highly technical products to market.

BA is forecasting just $4.05 to $4.25, but analysts are estimating $4.46/share 2012 EPS, AND, guess what?  Analysts are currently forecasting EPS of $5.67 for BA in 2013, which is 6.4% over BA’s 2011 earnings. Do you believe them?:

CAT-BA-PEG2012

How can a value investor take advantage of Analysts’ mistakes?  By waiting for the analysts’ next overheated incorrect estimate, which may be so ridiculously high that even a company posting strong gains can’t “beat” it, which is what happened with CAT in 2011, when analysts had somehow not factored in the expenses of CAT’s multi-billion dollar purchase of mining equipment maker Bucyrus.

When the stock gets beaten up, and discounted unnecessarily, make your move, and buy it, OR, do this:

Sell Cash Secured Puts: If you want to give yourself more breathing room, you can sell  cash secured put options below the stock’s current price, which will give you a lower break-even price. 2 other important benefits:  you’ll get paid now to wait, and you’ll often get paid much more than the next few quarters’ dividends.  Fortunately, CAT has rather high options yields which are much higher than its dividend yield.

In these two examples, CAT’s put options pay over 9 to 12+ times the amount of its dividends. The further out in time you sell options, the more premium you’ll get paid, and the lower your break-even price will be.  However, your annualized yield will also be lower, because your broker will be holding a cash reserve of 100 times the Put Strike Price in your account against each Put that you sell, until the put expires or is assigned or you buy it back to close out your position.

(You’ll find more info on these and over 30 other high yield Cash Secured Puts trades in our Cash Secured Puts Table.):

CAT-PUTS-2-23-12

How to hedge your gains with Covered Calls: Conversely, if you now own CAT shares, and you’re leery of a market pullback, selling covered call options will protect some of your profit, by giving you additional option income on your shares. The caveat is that, by selling a call option, you’re obligating yourself to sell your shares at whatever strike price you sell the calls at. Typically, the shares will get assigned near or at expiration, if the stock rises above the strike price.  So, you’re foregoing potential price gains, in return for immediate option income.

However, these 2 covered call trades each have strike prices above CAT’s current stock price, offering you the potential for an additional $3.80/share in price gains, if your shares get assigned. The longer-term August call options pay more than the May calls, and both call options heavily outstrip the corresponding dividend payouts. (One options contract corresponds to 100 shares of stock.)

(You can see more details for these and over 30 other lucrative option trades in our Covered Calls Table.):

CAT-CALLS-2-23-12

Financials: Although they aren’t high dividend stocks, these two DOW dividend stocks both have attractive Mgt. Ratios, and good interest coverage, but if you’re looking for 2012 growth at a reasonable price, CAT is the more undervalued of the two.  In fact, CAT is one of the few DOW 30 stocks to have a low 2012 PEG ratio. However, as CAT has risen almost 29% year-to-date, you may want to wait for a pullback before jumping in.

BA-CAT-ROE

Disclosure:  Author is short CAT put options.

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

Author: Robert Hauver © 2012 Demar Marketing All Rights Reserved

Make Over 20 % By Hedging This Top Dow Dividend Stock

By Robert Hauver

Although it’s nearly flat for the past year, the Industrial sector has been rising strongly over the past few months:

SECTOR-PERF-1-19-12

Promising earnings forecasts are one of the main reasons for this sector’s momentum, as it’s projected to be one of the top sectors for EPS growth over the next 5 years:

SECTOR-PEG-1-19-12

So far, Caterpillar, (CAT), has been one of the best stocks to buy in 2012 for price gains. If you bought CAT in late 2011, you’d have a nice gain already:

CAT-PERF-1-19-12

Although the market has been climbing so far in 2012, many analysts are forecasting a volatile road ahead in the first half of 2012.  So how can you protect your gains in CAT?

Fortunately, CAT has some of the highest options yields of any Dow dividend stocks, which will help you to protect a large % of your gains, via selling covered calls.

Different strategies you can use to hedge your gains and earn high yields:

1. Sell covered call options further out in time, to capture a bigger premium, and hedge more of your gains. This table uses CAT’s 2011 year-end price as a cost basis, and illustrates how, the further out in time you sell these $105.00 call options, the more option premium $ you’ll receive.

In the table below, the May option pays $7.50, which hedges almost 50% of the $15.11 year-to-date gain for CAT, whereas the Jan. 2013 option pays $13.65, which hedges over 90% of the gain. The higher, longer-term call premiums will also lower your break-even price.

The trade-off is that your annualized yields decrease as you sell further out in time. However, all of these trades achieve double-digit annualized “static yields”, and much higher potential assigned yields.  Static yield equals the call bid premium dividend by the cost basis of the underlying stock, and refers to a scenario in which the stock doesn’t rise above the strike price near expiration, so you keep the underlying shares:

CAT-EXPS-2012-01-19

(You can see more details on over 30 high yield Covered Call trades which we’ve discussed in recent articles in our Covered Calls Table.)

2. If you’re more bullish on the market and/or CAT, you could sell covered call options at a higher strike price, leaving yourself more opportunity for future price gains.

The table below uses CAT’s 1/19/12 closing price as a cost basis, and shows the differences in potential price gains at different strike prices, all expiring in August 2012.

Potential assigned yield refers to the yield on the difference between the stock’s price and the strike price.

In this example, the $105.00 strike price is $.71 below CAT’s $105.71, so if the stock rises above $105.00 near expiration time in August, the underlying shares may get sold/assigned away from you at $105.00.  This is the big trade-off of selling covered calls at a strike price “in the money” – you sacrifice potential future price gains for a higher option payment now.

The other two higher strike prices leave you more room for potential price gains/higher potential assigned yields, but pay lower call option premiums:

CAT-STRIKES-2012-01-19

The above call options pay almost 6 to over 10 times the amount that CAT’s dividends pay during this 7-month trade period.

Selling Cash Secured Put Options:

Conversely, if you’re interested in buying CAT, but you’re leery of its current price, you can sell cash secured puts at a strike price below CAT’s current price, and achieve a lower break-even price.

Selling put options obligates you to potentially have to buy the underlying stock at whatever strike price you sell the puts at.  “Cash reserve” refers to the amount your broker will set aside in your account, to insure that you have the money to pay for the stock, if it gets sold/assigned to you at expiration. For example, the $105.00 strike price requires a cash reserve of $10,500.00, which equals $105.00 x 100 shares of CAT.  (Each option contract corresponds to 100 shares of the underlying stock)

In these August 2012 put options trades, each lower strike price gives you a lower break-even, but also has a lower option premium.  So, you have to decide how aggressive to be – should you “nibble at the edges”, and sell put options further out of the money for a lower break-even, such as the $97.50 strike price below, OR, be more aggressive, and sell at a strike price closer to a stock’s current price, such as the $105.00 strike?:

CAT-PUTS-1-19-12

(Note: You can find more info on over 30 high yield Cash Secured Puts trades in our Cash Secured Puts Table.)

Financials: CAT’s mgt. efficiency ratios are higher than its peers’.  CAT’s Debt/Equity ratio is higher, but it has an Interest Coverage ratio of 5.9:

CAT-ROE-1-19-12

Valuations: Although CAT’s Price/Book is much higher than its peers, it appears undervalued on a PEG basis, and has enjoyed solid growth during its most recent quarter and fiscal year.  CAT is due to give its earnings report on Jan. 26, 2012.

CAT-PEG-1-19-12

Disclosure: Author is short CAT put options.

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

Author: Robert Hauver © 2012 Demar Marketing All Rights Reserved

2 Easy Ways To Earn 20% On Industrial Dividend Stocks

By Robert Hauver

Although Industrials are down approx. -4% year-to-date, this sector may hold some of the best stocks to buy moving forward. Standard & Poor’s ranks Industrials as #2 in projected EPS growth for 2012, right behind Tech, which gives it the 3rd lowest PEG ratio for 2012:

S&P-EPS-Q3

(Data source: Standard & Poors)

Thus far, 86% of S&P 500 Industrials have beaten or met their Q3 2011 Earnings Estimates, 2nd only to Tech.

S&P-EPS-BEAT-Q3-'11

(Data source: Standard & Poors)

Although this sector looks attractive, finding undervalued high dividend stocks here with strong metrics is still a challenge.  A different approach would be to look for a lower-yelding dividend paying stocks, that have stronger growth and financials, and then utilize options to ramp up the dividend yields on these dividend stocks. Both Caterpillar and Cummins have less-than-avg. dividend yields, but you can greatly improve upon their dividends by selling options.

CAT-CMI-DIVS

Covered Calls: Take a look at the big difference between these high option yields and the dividend yields during these 6-7 month trades.

CAT’s call options pay over 9 times their dividends, while CMI’s pay over 15 times.

(The call and put options listed in this article for CAT expire in May, and those for CMI expire in June.)

(You can find more details on this and more than 30 other high yield covered call trades in our Covered Calls Table.)

CAT-CMI-CALLS

Cash Secured Puts: Another proven tactic is selling cash secured puts below the stock’s current share price, in order to achieve an even lower break-even price. The put trade listed here for CMI has a break-even only 3% above CMI’s 52-week low. These put options pay 9 to 16 times more than the dividends in these trades.

Your broker will secure a cash reserve in your account, equal to however many put contracts you sell, times the strike price of the put you sell. This amount is released once the puts expire or the trade is closed. Hence the term, cash secured puts. You’ll get paid for any puts and calls that you sell within 3 days of the trade, often even the same day. Note: put sellers don’t receive dividends, but call sellers do.

The best time to sell cash secured puts is normally when the stock is at the lower part of its range, which will give you an even lower break-even. Both CAT and CMI are higher-beta stocks, which fluctuate widely with the market, so check out their put prices during the next pullback.  If you need to be even more conservative, you could also sell cash secured puts at a strike price further below the current share price. This will give you a lower premium, but a lower break-even also.

(You can see more details on these and over 30 other high yield options trades in our Cash Secured Puts Table.)

CAT-CMI-PUTS

EPS/Sales Growth: Both CAT and CMI had strong EPS growth in their most recent fiscal years, and also strong sales and EPS growth in their most recent quarter:

CAT-CMI-EPS

Valuations: CAT’s PEG for its next fiscal year is very low, while CMI’s is consistent with the sector’s .87 PEG. CAT’s Price/Book and Price/Sales are consistent with its industry, while CMI’s Price/Book is a bit higher than its industry avg. of 2.58, but its Price/Sales is lower than the avg. of 1.30

CAT-CMI-PEG

Financials: Although CAT carries a heavier debt load, its interest coverage ratio is 5.9x.

CAT-CMI-ROE

Disclosure: Author is short puts on CAT and CMI.

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

Author: Robert Hauver © 2011 Demar Marketing All Rights Reserved

Two High Yield Strategies For Hedging Dow Dividend Stocks

By Robert Hauver

As of  Oct. 27th, the S&P has come back 17% since its nadir of 1099.23 on Oct. 3rd,  leaving some investors nervous about how long the current rally can last. If you’d like to participate in the rally AND have some protection, selling covered calls and/or cash secured put options may interest you.

The key is to use these strategies with dividend stocks that you’re comfortable owning. In our 2 examples, we’ll use Caterpillar, (CAT), which has been one of the best stocks to buy in this current rally, since it’s up more than any other Dow dividend stocks over the past trading month.

Selling Covered Calls to hedge your gains: (You’ll find more details on this and over 30 other high yield covered call trades in our Covered Calls Table.)

If you’d had the prescience to buy CAT on Oct. 3rd, when it began to rise from its year-to-date low of $70.55, all the way to $96.33, (up 36.5% through Oct. 27th), you could hedge over a third of your gain by selling covered call options. Here’s how it works:

(By selling covered calls, you’re committing to sell the underlying shares at whatever strike price you sell the call option at. Each option contract corresponds to 100 shares of the underlying stock, so we’ll use 100 shares of CAT to keep this example clear.)

1. Underlying stock cost/share: $70.55

2. 10/27/11 closing cost/share: $96.33

3. Find the Options Chain for CAT, and click open the May 2012 options. There are call options at a strike price of $97.50, which are selling for $9.55, roughly 37% of the Oct. gains that CAT has made. The idea here is to sell call options above the current strike price, which are “out of the money”. This allows you additional potential price gains if the shares get assigned/sold:

CAT-SWB-CALLS

4. You’d “sell to open”,  one $97.50 call option contract for each 100 shares of CAT that you own.  This obligates you to potentially have to sell your shares of CAT at $97.50 up until the expiration date of May 19, 2012. (US options expire on the 3rd Friday of the month, and are usually deemed expired or assigned during the next 2 days, Saturday or Sunday, by your broker.) In this example, you’d receive $955.00 for each contract you sell. This money is normally credited to your account by online brokers the same day, or within 3 business days of the trade at the latest.  You get paid right away, instead of waiting for the quarterly dividend.

Your breakeven is $60.08, your initial cost of $70.55/share, minus the call option sale of $9.55/share, and minus the $.92/share in dividends you’ll qualify for prior to expiration.

Notice how the call bid premium, $9.55, is over 10 times the dividend of $.92?

CAT-CALLS

Outcome Scenarios For Covered Calls:

1. CAT doesn’t rise above $97.50 – The $97.50 call options expire worthless, leaving you with your $955.00 option annualized static yield of 24.46%, plus the 2 quarterly dividends totaling $92.00/100 shares, and you still own your shares.

2. CAT rises above $97.5o, enough for your shares to be assigned/sold away from you at $97.50/share. In addition to the call option sale money of $9.55/share, your profit also includes $26.95/share, (the difference between the $97.50 and your $70.55 cost), and the 2 quarterly dividends, for a total annualized assigned yield of 95.84%.

Please note: this is an extremely high annualized assigned yield, because of the big price gain involved. If you’d bought CAT at $96.33 on 10/27/11, and it was assigned/sold at expiration in May, your total assigned yield would be 21.96%, which is still very attractive.

In scenario #2, it depends upon whether or not there are any call option buyers who paid a price that’s lower than the difference between the $97.50 strike price you sold the calls at, and CAT’s price near or at expiration. If it’s advantageous, these call buyers would exercise the call option to buy your shares at $97.50. (In general, option buyers tend to exercise call options to buy a stock as it gets closer to the expiration date.)

3. CAT rises above $97.50, but not enough for your shares to get assigned/sold away from you.  In this scenario, it depends upon whether or not there are any call option buyers who paid a price that’s lower than the difference between the $97.50 strike price you sold the calls at, and CAT’s price near or at expiration. The outcome is the same as scenario #1.

Selling Cash Secured Puts: (There are more details on this and over 30 other high yielding cash secured put trades in our Cash Secured Puts Table.)

Suppose you missed the big October move for CAT, and you still want to own it, but you don’t want to pay the current price. Selling cash secured puts at a strike price below the stock’s current price offers you a lower break-even price than the current stock price, and immediate income. However, unlike selling covered calls, you don’t collect any dividends. We’ll use the same May 2012 expiration month for this put option example.

Since CAT closed at $96.33, let’s sell one $95.00 put option, just “out of the money”. This obligates you to potentially have to buy 100 shares of CAT at $95.00/share near or on the expiration date of May 19, 2012. Your broker will reserve/hold $9,500.00 in your account when you sell this $95.00 put, which is the “cash reserved” part of the equation.

As with the call options, these puts pay over 10 times what the dividends pay: $10.15 vs. $.92.

1. You’d “sell to open” 1 put option contract for every 100 shares of CAT that you want to own. You receive $10.15/share, or a total of $1015.00 for each option contract sold.  Your breakeven is $84.85, which equals the $95.00 strike price, minus the put price of $10.15 that you sold for.

CAT-PUTS

Potential Outcome Scenarios For Selling Cash Secured Puts:

1. CAT doesn’t fall below $95.00 – The $95.00 put options expire worthless, leaving you with your $1015.00 profit, a 19.31% annualized  yield.  Your broker releases the $9,500.00 cash reserves in your account.

2. CAT falls below $95.00, but is still above your breakeven – If CAT only falls $5.00, for example, to $90.00, you still may be assigned/sold the 100 shares at $90.00, if it’s advantageous for a put buyer to exercise his put option.

However, since your $84.85 breakeven price is still lower than CAT’s $90.00 price, you could sell these 100 assigned shares and still turn a $5.15/share profit, although it’d be a smaller one than your initial put profit. Or, you might choose to hold the shares for future price appreciation and dividend income.

3. CAT falls below your breakeven – You can “retreat” from an underwater sold put position at any time before expiration, by “buying to close” the sold puts, which closes out the position, and “selling to open” a new put position, at a lower strike price, and/or at a different expiration month.  Generally, the further out in time you sell options, the higher the premiums are, so there’s a chance of recouping a loss by selling longer-dated options.  A good idea is to keep a spreadsheet with your breakeven price vs. the current price of the stock, to monitor your position.  This spread will be different than the price you sold the option for and the option’s current price.

Disclosure: Author is short puts of CAT.

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

© 2011 DeMar Marketing. All Rights Reserved.

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

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.

Dow Dividend Stocks – Top 7 Cash Secured Put Options

By Robert Hauver

Dow dividend stocks aren’t usually mentioned in the world of high dividend stocks, but selling cash secured put options is a way you can earn some impressive double-digit annualized yields out of even these modest dividend paying stocks.

We screened for the top 7 put selling yields for DOW dividend stocks and came up with these 7 option trades:

DowPuts9-7-10

(All of the above put bid yields are based upon 100% cash reserve)

As you can see, these put yields far outstrip the dividend yields, and in a shorter 5-6 month time period.  Hence, the annualized yields are pretty impressive.

We’ve added some of these put options this week to our Cash Secured Puts Table, which will show more detail.

Why sell cash secured puts, instead of just buying the stock outright?

  1. More Risk Protection – By earning the higher put option $, you’re lowering your break-even cost, and giving yourself greater downside protection.
  2. Better Cash Flow –  You get paid the put premium within 3 days of selling puts, as opposed to waiting each quarter for a dividend payout.
  3. Higher Yields – This happens 2 ways: In the above trades, the put yields are 2 to 9 times that of the dividend yields.  Also, with your lower breakeven cost, if the shares do get assigned/put to you, the ultimate dividend yield on the underlying shares will be higher, due to its lower cost.
  4. Potential Tax Deferral –  The IRS rules state that,”If a put you write is exercised and you buy the underlying stock, decrease your basis in the stock by the amount you received for the put. Your holding period for the stock begins on the date you buy it, not on the date you wrote the put.” (Source:www.IRS.gov/publications)         This means that you don’t have to pay taxes on the put $ you received until you sell the assigned underlying shares. If you hold the underlying assigned shares for more than 1 year, you’ve also converted a short-term gain into a long-term gain.
  5. Knowing your “trade range” before trading–  This strategy tells you your maximum gain and break-even cost, before you invest, as opposed to buying, and hoping for price appreciation.

Cons

  1. Options gains are always taxed at short-term capital gains rates, which will be higher than qualified dividend tax rates.
  2. Put options sellers are required to have 100% “cash reserve” by their brokers, i.e., your broker will set aside 100% of the value of the underlying shares against which you sell puts. 100% cash reserve is always required in an IRA account, but, investors with thorough options experience may qualify for Options Level 3 trading status, which lets the broker reduce the cash reserve to a lower 25-35% approx. range, thereby employing leverage.  A note of caution here: if you do employ this type of leverage, it’s very important to keep track of your potential exposure, and not get in over your head.
  3. Cash secured put selling is a strategy that requires a bit more of a hands on approach, as opposed to the “buy and hold” strategy. However, this strategy shouldn’t be confused with day trading – Put sellers make their sale, collect the put $, and monitor the put’s value during the investment term, as opposed to jumping in and out of a trade every day.
  4. Less rally participation – The maximum gain on selling cash secured puts is the amount of $ you receive when making the put sale, so, this profit could potentially be less than the eventual price appreciation of a stock.

Is it worth it?

Some investors would argue that, if you do nothing, and the stock’s price declines, you could also own the stock a lower cost.  That could be happen, but looking at the possible outcomes in the market, selling cash secured put options offers a greater chance for income:

PutSellingOutcomes

Another issue to consider here is time value of money, and what you’ll earn on your money, while you wait for a stock to hit your price.

In addition, due to the timing factor in options, time favors an option seller over an option buyer, since the buyer must guess the stock’s ultimate price direction and price level, and must be correct before the option expires.  That’s often a very tall order, and it’s one of the reasons that 3 out of 4 options expire worthless – which is a distinct advantage for an option seller – time is on your side.

Disclosure: Author is short INTC puts.

Disclaimer: This article isn’t intended as investing or accounting advice.

Dow Dividend Stocks – Top 5 Covered Calls

By Robert Hauver

Maybe you want to buy blue chip Dow dividend stocks, but you don’t have much faith in price appreciation, given the market’s performance in 2010 thus far.  Selling covered calls often allows you to lock in a much higher yield than the current dividend yield of most dividend paying stocks.

We screened for the highest at the money covered call trades for the Dow 30, and came up with yields ranging from 8.54% to 10.17% for CAT, GE, BA, MSFT, and INTC. (Full names in table below.)  Pretty nice yields, especially when you consider that the annual yields for these 5 stocks range from just 2.18% to 3.20%.  Given that these option trades are all 6 to 8 month trades, their annualized yields are even higher, as you can see below:

DowCovCalls-9-1-10

(We’ve listed these trades this week in our Covered Calls Table, which gives you more specifics.)

Here’s a Performance table which lists each stock’s Year-to-Date, 2nd Quarter, and 1-Year price performance:

Dow5-Perf.2010thru9-1

This group’s Industrials far outperformed the Techs in a declining market YTD.  The overall Tech sector also lagged Industrials over the past year, with Industrials up 18.3% and Tech up only 9.8%.  Year-to-date, Tech is down -2.9%, and Industrials are up 3.1%.

As most value investors will tell you, lagging sectors can often be a good place to look for bargains.  The 2 Tech firms in this group, Intel, (INTC), and Microsoft, (MSFT) both have PEG ratios below 1, a statistic which is generally recognized as indicating that a stock may be undervalued.

Dow5PEGS-9-1-10

As with any strategy, there are pros and cons you should consider when selling covered calls.

Pros:

  1. Immediate Cash Inflow – Instead of waiting each quarter to collect dividends, when you sell a covered call, you’ll receive the call bid premium money into your account within 3 days from making the sale, often even the same day, depending upon your broker.  Of course, you’ll also keep collecting the dividends on the underlying shares.
  2. Superior Yield – As you can see from the table, these particular call yields are 3 to 4+ times the dividend yields.  This strategy allows you to transform a modest yield into a superior one.
  3. Downside Protection – The call premium $ you receive lowers your break-even cost, giving you more downside protection.
  4. You Know The Trading Range Before Making The Trade – This strategy tells you your exact upside profit potential, and your downside break-even, before you trade, as opposed to buying a stock and trying to determine what your upside potential will be.
  5. The Odds Are With You – It’s been proven that 3 out of 4 options expire worthless. When you’re an option seller, time is on your side, as opposed to the options buyer, who must not only guess the stock’s ultimate direction and approximate price, but must do it before expiration.

Cons:

  1. Limited Rally Participation – Once you sell a covered call, you’re obligated to deliver the underlying shares at your sold call’s strike price if they get assigned, (sold) away from you, no matter how high the stock goes. So, if you think there’s going to be a big rally, then you may not want to sell covered calls.
  2. Higher Entry Costs – You must own 100 shares of the underlying stock for every covered call that you sell.  Therefore, covered call sellers have a greater initial outlay than call options buyers.
  3. Assignment Risk – Selling covered calls against a stock puts you in jeopardy of having your shares sold away from you.  You have to weigh many factors, such as the dividend yield today, and potential dividend growth, and possible price appreciation.  However, if you think that the market is going to be range-bound, or bearish, then the covered call strategy will give you some added downside protection.

Deciding whether or not to sell covered call options comes down to many issues, such as, your risk profile and your market outlook.  If you want to capture some cash yields immediately, and not wait for the market to decide its direction, then this strategy may be right for you.

Disclosure: Author is long shares of INTC, and short INTC calls.

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

7 Dow Dividend Stocks With 10%-Plus Put Option Yields

By Robert Hauver

If this week’s downturn is making you jumpy, maybe you ought to think about taking advantage of the pullback, by selling cash secured put options on some Dow dividend paying stocks. Although these stocks wouldn’t be considered high dividend stocks, they do currently have very attractive put option yields, ranging from just below 10% to over 12% for a 5-6 month trade.

The pullback has increased the volatility and the bid prices on these put options, which benefits option sellers, AND achieves a lower break-even price.  In fact, the put option bid yield far outstrips the dividend yield on all of these 7 Dow stocks:

COMPANY SYMBOL 8/12/10 STOCK PRICE PUT OPTION BID PUT YIELD ANNUALIZED PUT YIELD DIVIDEND YIELD EXPIRATION MONTH PUT STRIKE PRICE BREAK-EVEN PRICE
CATER-PILLAR CAT $67.59 $6.95 11.48% 25.87% 2.60% 11-Jan $67.50 $60.55
JP Morgan Chase JPM $37.84 $3.65 10.78% 24.29% 0.60% 11-Jan $37.50 $33.85
AMERICAN EXPRESS AXP $42.44 $4.00 10.53% 23.73% 1.70% 11-Jan $42.00 $38.00
BANK OF AMERICA BAC $13.16 $1.42 12.26% 23.55% 0.30% 11-Feb $13.00 $11.58
BOEING CO BA $64.95 $5.90 10.42% 20.02% 2.60% 11-Feb $62.50 $56.60
Hewlett Packard HPQ $40.25 $3.65 10.04% 19.29% 0.80% 11-Feb $40.00 $36.35
Home Depot Inc HD $27.60 $2.39 9.71% 18.65% 3.50% 11-Feb $27.00 $24.61

Although its put yield is just below 10%, Home Depot is on this list due to its 3.5% dividend yield, the highest in this group. We’ve also added Home Depot to our Cash Secured Put Table this week, as it has an attractive 18%-plus put yield. However, as you can see from the table above, most of these Dow 30 dividend stocks don’t have very attractive dividend yields, which is another reason for income investors to consider selling cash secured puts on them instead.

The benefits of this strategy are 4-fold:

  1. Immediate income – You receive the cash from put sales in your account within 3 days after the trade.
  2. Much higher yields – This varies, of course, but in times of increased volatility, put yields often outpace dividend yields.
  3. Lower breakeven – All of the above puts are “out of the money”, (put option strike price is below the stock price), which gives you a lower breakeven price, and more protection against a falling  share price than owning the stock outright would.
  4. Tax deferral – You don’t have to pay taxes on sold put options until they expire, or you close your position. Thus, if you hold any of the above puts until their Jan/Feb. 2011 expiration, you aren’t liable for taxes until the April 15, 2012 deadline for paying taxes on 2011 gains.  In fact, if you’re assigned the underlying stock, you don’t have to pay taxes on the put money that you received until you sell the underlying assigned stock, since the IRS states that your tax basis for the assigned stock is lowered by the money you received for selling the put options.  Quite a nice break for investors.

Caveats:

  1. Short term tax rate – Option profits are taxed at short term rates, even if they’re held for more than 12 months, as opposed to the qualified dividend tax rate, which is now 15%, but may rise in 2011.
  2. Selling vs. Buying options – Option sellers usually have to put up much more cash than option buyers, particularly when selling cash secured puts.  Brokerages generally will require a “cash reserve”, equal to 100% of the cost of the underlying shares.  If you have a 100% cash reserve requirement, your initial cash outlay for selling cash secured put options is similar to buying stocks, with one big difference: your cash outlay will be reduced by the premium $ you sell the options for, within 3 days. (Also, if you qualify for option level 3, your broker may reduce this reserve requirement to 25 -35%).

Disclosure: Author is short BAC puts.

Disclaimer: This article is written for informational purposes only.