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Tuesday, June 25, 2024

Hedging Your Way To Healthy Dividends – Part 2

Time to get a little more conservative

In Part 1 of this post, we talked about the potential long-term value of taking a chance on companies that used to pay dividends but don't at the moment.  In addition to the 7 selections we had last Tuesday, I would urge members to keep on the lookout for additional prospects we can discuss as the long-term benefits of catching these stocks at the lows can be amazing!  This was the same logic that led me to pound the table back in March on C, BAC, WFC, JPM and even the hated GS – stocks that have tripled or better in just 3 months

We had a very easy time selecting those stocks as we were able to hedge our entries and our long-term logic was that, at those low prices, we could be fairly sure of producing a good option income even if they never restored the dividends but the kicker was the possiblility of owning, for example, C at $1.50 down the road when they go back to paying $1 per year dividends.  Imagine having a year's salary put away on stocks that pay you almost a year's salary every year in dividends alone! 

Don't worry, you didn't miss a once-in-a-lifetime opportunity, we just have to work a little harder at the moment.  As I noted with our LYG example, there are still beaten-down financials that are worth a look and today we'll look at 2 more of our 21 Tuesday selections (one now, one later) and go over the trading plans for those positions.  Note that the LYG trade ties up just $1,035 in cash to make (hopefully) $1,465 in year 1 with a commitment of $3,535 if you end up owning all 1,000 shares on Jan 15th. 

By making sure you are on top of these figures, a person making $30,000 a year who has $5,000 in an investment account count take a modest 6-month gamble like this.  If this trade pays off, $5,000 becomes $6,465 and 500 LYG shares are secure (about $2,500 worth) or, at worst, you have 22% more cash for the next trade.  The next trade secures another potential dividend payer and if every 6 months you can secure just another $2,500 worth of dividend paying stocks for under $2,000 then in just 10 years, investing just 10% of a $30,000 annual salary, you could, very conservatively, have $50,000 worth of dividend paying stocks supplimenting your income.  Perhaps they gain value, perhaps they don't but if they once again begin paying dividends down the road, you will be well on your way to having a nice retirement income.  Get rich quick schemes rarely succeed but getting rich slowly often works out quite well

So LYG was a speculative play – they may pay a dividend again, they may not.  That is why the potential returns on cash are so high.  While those investments are appropriate for investors with many years of income ahead of them or as a speculative potion of a larger virtual portfolio, we don't have to take big risks to get big returns on some stocks.  Our second category of dividend payers was 9 stocks that we were pretty sure would continue paying their dividend.

TNK was one I liked as they have pre-sold much of their 2009 and 2010 capacity and they seem to be in reasonable financial shape in a very beaten-down industry.  Even in a depression, oil must be shipped from here to there right?  While they did cut their quarterly dividend by 18%, the next dividend is scheduled to be 59-cents and we are already past Q1 earnings.  While an 18% dividend cut may have disappointed existing shareholders and sent the stock back down to $11.09, .56 times 4 is $2.24 a year – that's a 21% dividend!  The stock bottomed out at $7 on March 9th and if we plan on doubling down should it get that low again, then our average entry on 400 shares would be $9.17.  Let's say they cut the dividend in half to $1.12 a year as they struggle through the depression – that's STILL a 12% ROI without even selling any options.  Sound interesting?  Let's see how we can improve our odds:

  • Buying 200 Shares at $11.09
  • Selling Nov $10 calls for $2.33 and Nov $10 puts for $1.57 nets $7.19 ($1,438).  If called away at $10 in November ($2,000), the profit would be $562 (39%). 
  • If the stock is put to us below $10 on Nov 20th, our average cost of entry on 400 shares would be $8.60 so a total potential commitment if $3,440

If we only hold the stock through November, we will only catch the August dividend but that's still a nice, additional .59 x 200 or $118 FOR A SINGLE QUARTERLY DIVIDEND (and that's on just $1,438 out of pocket)!  Of course, we teach our members how to roll the putter and caller back as we get closer to expiration and that is just one of the many adjustments that can be made to keep us in the stock.  It's hard to get used to but the key component of a trade like this is you do effectively own 200 shares at $7.19 – that does not change.  That means you can buy 200 more shares at any price up to $14.99 and your average cost per share would still be lower than today's $11.09.   Embracing the math is key understanding adjustments down the road.  It's not that complicated but it does take practice to get used to the little adjustments that can add 10% here and there to your long-term returns.

Also, it is important to note that these are very basic ways to play.  I'm sure many of our members have noticed that we can sell the July $10 puts and calls for $2.30, netting $1.21 in premium in just 60 days vs. $2.81 in 180 days selling the November combination.  Active management of positions does have it's rewards of course but I hear from many people who say they don't want to be in positions that they have to adjust all the time and, while I hardly consider once every month or two "all the time," I'm trying to make these as easy as possible.

Personally, I think TNK is very undervalued and I would enter this play by selling the July $10 call now, stopping into the stock at no more than $11.50 but hoping for $10.50 as an entry (as they are in a downtrend at the moment).  I would also be selling the Nov $12.50 put, now $3.20 for no less than $3 but hopefully for $4+ so my worst case entry is $6.77/9.63 and my better case would be $4.77/8.64.  Since I very much like TNK's long-term prospects, I will be happy to double down (which would be 800 total shares assuming I have the November puts assigned to me) even if they go back to $7.24 so my (hopefully) worst-case plan is to own 800 shares at an average price $8.44 or 24% lower than today's price.  That means I would want to put aside $6,752 for this trade although my initial cash outlay would be no more than $1,354. 

Even if you have no margin to work with in your virtual portfolio and have to hold aside the entire $6,752, if you don't get the cheap entry and do get called away in November, your profit plus dividend is $764, still an 11% return on the entire at-risk amount in just 6 months.  This is very nice for such a well hedged position and makes a great trading plan to scale into a long-term holding.  Why do I like this play better?  Because with virtual portfolio margining you are only tying up about $2,000 to make $764 in 6 months (38%) and there is upside from there.

So we have an aggrssive way to play committing $6,752 to collect $764 but really aimed at making sure we do own the stock down the road.  Our $4.77 net entry on the first 200 shares means I will happily buy 200 more for $12.50 if I have to and again, there are "rolls" we play in Member chat that give us dozens of other options along the way – these are very fluid positions over time for the active investor.  The simple play risks just $3,440 at most to collect $670 in profit and dividends EVEN IF THE STOCK DROPS 10% OVER THE NEXT 6 MONTHS!

To sum this play up quickly – Here's a way to play TNK that gives you a 19% return in 6 months as long as the stock stays at 90% of its current price or better.  You've gotta love this stuff! 

 

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