Juicy Covered Calls on High Dividend Stocks

Continuing with my miniseries on capturing high options volatility by selling option premium, today we’ll be looking at covered calls on high dividend stocks. I’m purposely selecting high dividend stocks so that even if the stock drops further, we have the added cushion of a dividend. So far, all of these companies have been faithful in paying their dividends. (If you’re unfamiliar with options, please check out the resource links for educational info. The covered call strategy is discussed in detail in Recipe #7: Covered Call Casserole.)

The set-up
I’m looking for richly priced options on lower priced stocks that pay a decent dividend. I’m also looking for at-the-money or slightly out-of-the-money options. The further in-the-money an option is, the more downside protection you get. Here are my input parameters:

Stock price < $50
Dividend Yield > 3%
Current option volatility > Historic volatility
Open Interest > 50
Downside Protection > 5%

The results
Here’s what my options search software spit out. Although none of these trades are risk-free, the top five are the ones I feel have less risk associated with them compared with the bottom two which are financial stocks. Out of the top five, three are shippers (you’ll note that Diana Shipping was on the naked put list a couple of days ago, too), one jet leasing company (Aircastle), and one utility (Ameren).

All of the companies including investment house Blackstone are still paying their dividends, although Aircastle and Golar cut theirs this year. Diana Shipping actually increased its dividend. Nice! My problem with Blackstone is that its price support level is tenuous. If you still like it, you might want to wait a couple of days to see if its support level holds but note that you’ll be exchanging a reduction in trade risk for a smaller options premium. (The higher the price of the stock, the more expensive the call option and vice versa.)

[In the following table, D/P= Downside Protection; % Un = % Unassigned; % Assn’d = % Assigned. Click on table for larger view.]

Other strategies
Writing calls that are deep ITM (in-the-money) is one way to decrease your downside risk. However in this scenario, if your stock doesn’t fall below the strike price of the written call, you risk losing it, especially near the expiration date.

That’s it for now.

2 Responses to “Juicy Covered Calls on High Dividend Stocks”

  1. Michael Comeau says:

    Interesting ideas and I appreciate the dividend angle, but those premiums are rich for a reason. Stuff like DRYS and DSX are more than likely to be super super volatile.

  2. Dr. Kris says:

    Hi Michael!
    Thanks for your thoughtful post, and yes, options premiums are generally rich for a good reason, and usually the reason isn’t a bullish one. All of the dry bulk shippers have been subject to the global decrease in commodities consumption and their futures may indeed be in jeopardy unless demand for commodities steps up and/or credit becomes available in the near future.

    I didn’t say any of these plays are without a certain amount of risk–that’s why the options premiums are so rich. On the other hand, there are many other companies that are in even worse situtations without the rich premiums (think the automakers). My point is: if you believe that in the long run the company will survive, now is a great time to benefit from selling premium. Not only do you get an immediate infusion of capital into your account, but this capital also affords you downside protection should the trade move against you. (And so does the dividend, if the company can still afford to pay it.)

    Diana is down 67% from its all-time high and DryShips is down 90%.Of course, that doesn’t mean that these stocks can’t go to zero, but so far, they seem to be holding steady. We’ll see!

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