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Sunday, February 5, 2023


Hedging Your Way To Healthy Dividends – Part 3

We're going to go out with a bang here and give you a 3-for-1 in this final post on the issue.

In Part 1, we discussed the idea of going after former dividend payers who may bounce back while creating an artifical dividend through option hedging.  In Part 2 we looked at using the buy/write strategy to give ourselves a nice discount on the stock, giving us a 30% hedge on the stock on top of the dividends.  Today we will look at a couple of ways to play the safer bets and how to simply and effectively boost your dividend yield while also protecting your investment.

In Tuesday's post we had 21 dividend payers divided into 3 categories.  We'll look at what we consider a "pretty safe" dividend payer, PGH, who pay a MONTHLY dividend of about 8 cents on a $8.11 stock (12%) as well as our long-time favorite, KMP who pay about $1 per quarter and our Blue-Chip selection will be CAT, who have a 4.9% dividend and are trading at a nice, cheap $34.31.

As we have 3 trades here I'm not going to go too heavily into the merits of each one.  Suffice to say we like them at these prices and we like the option hedges we can put to work on the postions… 

PGH is a stock we went crazy for back in March, when they were under $5 but that was when they were in the category of stocks where people felt the dividend was in jeopardy.  It didn't take much for them to fly back to $8.11 but, through the magic of hedging, we can knock that price back to an entry price of $5.29 by selling the Jan $7.50 puts and calls.  As always, our major risk is that the stock falls below $7.50 and another round of shares are put to us at that price on Jan 15th.  That would create an average entry of $6.40, which is 21% below the current price.  Should we get called away as $7.50, that would be a $2.21 gain on cash so 42% PLUS 7 months worth of dividends, perhaps another .56.

Sticking with our $5,000 per position maximum risk, we can make the play the following way:

  • Buying 400 Shares at $8.11 ($3,244)
  • Selling 4 Jan $7.50 calls for $1.50 and 4 Jan $7.50 puts for $1.32, netting $2.82 ($1,128)
  • If the stock is put to us on Jan 15th we will own 800 shares at an average of $6.40 ($5,120)

As long as PGH keeps paying an 8-cent monthly dividend, our annual return on $5,120 is a whopping $768 or 15%.  As a kicker, PGH paid a .20+ monthly premium from Aug 2005 through Sept 2008 – THAT'S why we like this play.  Look at it as a way to offset higher energy costs – if you invest $5,120 in PGH, if gas goes back to $4 per gallon, there's a very good chance you'll be getting a $160 monthly check to offset the costs!

KMP is also in the energy business so be aware that these two are NOT diversified as a set but there's nothing wrong with going halves on each for your energy segment if you are limited in investment size.  Another long-time favorite of ours, KMP is going to be less exciting than our smaller plays but also closer to a Blue-Chip investment.  Since the stock is closer to our budget and does pay a $1 dividend in July and October, this is a good time to learn one of our "stupid options tricks" that lowers your risk significantly on a stock.

  • Buying just 100 shares of KMP for $47.55 ($4,755)
  • BUY the Jan $57.50 put for $12.35 ($1,235)
  • Sell the Jan $37.50 puts for .95 ($95).
  • Sell the Jan 2011 $55 calls for $1.20 ($120)

This may be tough to get your head around but you are paying a net of $57.75 for your shares and the put options you purchased guarantee your right to sell those shares (should you wish) on Jan 15th for $57.50.  Your risk on the trade is .25 as long as it doesn't fall below $37.50 and trigger the other put.  That being the case, a stop should be placed on that put at $1.50 so you are now risking losing .80 between now and Jan 15th.  If you do NOT stop out the put, you would still be able to exercise your put to sell your existing shares for $57.50 and you would have another 100 shares put to you at $37.50 and you would still have the Jan 2011 caller at $55 but they would be far out of the money of course.  That would leave you in KMP at net $3,775 – 20.6% lower than the current price and that would make your $2 dividend collected by Jan 15th 5.3% over 6 months.

Our final selection is CAT, another much loved pick that's no longer the bargain it was in March.  We like CAT on the global infrastructure stimulus as well as the weak dollar.  For CAT we looking to collect a .42 quarterly dividend on a $34.31 stock (5%) and here the best play is a very simple one:

  • Buy 200 shares of CAT for $34.31 ($6,862)
  • Sell Jan 2011 22.50 calls for $14.20 ($2,840)

That puts us in 200 shares at net $20.11 ($4,022) with no downside obligation, protected against a 41% drop in the stock.  Our expectations are to collect 7 dividend payments (expiration is Jan 21st, 2011 and dividends are usually paid in the first half of the month) of .42 or $2.94, which is 14.6% over 20 months – not bad with a 41% margin of error!  Of course we could get fancy and sell some puts too and, if you have a margin account, that's a no-brainer but this is the sort of return you can be happy with straight out and, even if you do get called away at $22.50 in 2011 – that's still yet another $2.39 in profit, an 11.9% kicker to close out the trade.

Yes, dividend paying stocks provide the best return in a sideways or even a down market.  Learning how to use options to hedge your dividend paying stocks can make them even more rewarding, allowing you to own more shares, collect greater net dividends as well as providing you with solid protection in the event of a downturn



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First, thanks for the series of posts – great stuff.
If you take a look at the KMP trade on the TOS analyzer I think you will find it is a better trade without selling the 2011 55 calls.  I realize they will be rolled or otherwise dealt with but they sure limit the upside.

I have 1300 shares of JNJ. I just bought back a call when the stock dropped last week so i’m ready to enter  into another. Still think the Jan 50’s are the way to go? Hedging in with 4 lots at a time?
Thanks for all your help.

[…] Hedging Your Way To Healthy Dividends – Part 3 […]

Good Morning Phil & all

Asia Markets :    Tuesday, May 26, 2009
(The following is from Yahoo; please cross check with other sources to confirm.)   

Australia All Ordinaries*             3781.60          46.30       1.24%
Nikkei Average*                            9310.81        -36.19      -0.39%
Shanghai Composite*                2588.57        -21.43      -0.82%
Hang Seng*                                16991.56        -130.26    -0.76%
Seoul Composite*                       1372.04         -28.86     -2.06%
Singapore Straits Times*           2238.79         -28.67    -1.26%
Bombay Sensex*                       13602.42        -321.28    -2.31%
Baltic Dry Index                             2786.00           79.00     2.76%

*at Close

Asian Markets Pressured by North Korean Tensions

Asian markets edged lower Tuesday with stocks in Seoul ending the session down 2 percent after North Korea threatened to launch more missiles while investor doubts about the world economy kept riskier assets such as the euro under pressure. North Korea further raised tensions after its nuclear test on Monday, though analysts believe the market impact will be short-lived in a region growing accustomed to Pyongyang’s actions.

Japan’s Nikkei ended 0.4 percent lower, weighed by tech shares though slides were checked by defensive shares such as drugmakers and communications companies.

Seoul shares underperformed the region, closing down 2 percent, pressured by reports North Korea was planning another missile launch. Shares in companies with interests in North Korea declined.

Australian stocks rebounded from early lows to close up 1.4 percent, as iron ore miners jumped. Earlier a top Rio official said there were signs of a pick-up in Chinese iron ore demand.

Hong Kong shares closed 0.8 percent lower, following a weak start on most major regional markets, but property stocks held strong, buoyed by more optimistic forecasts on home prices for the second half of 2009.

Singapore’s Straits Times Index slipped 1.3 percent.

China’s Shanghai Composite Index lost early gains to decline 0.8 percent, in low volume, with gains in renewable-energy companies restrained by declines in coal miners.

At 2 pm, Bombay Stock Exchange’s Sensex was at 13686.84, down 226.38 points or 1.63 per cent. Indian markets were witnessing selling pressure after European markets opened lower. All the sectoral indices, except IT space, were in the red.

Oils, Political Risk Depress Euro Shares

European shares fell in early trade on Tuesday as political risk reared its head with a reported missile launch by North Korea, further dampening a rally that has added a third to equities since early March.

The FTSEurofirst 300 index of top European shares was down 1 percent at 849.46 points, on track for its third day of falls in the last four.

The index, which is up 33 percent since hitting a lifetime low on March 9, was weighed down by oils, with BP, Royal Dutch Shell and Total falling 1.1-1.6 percent, tracking a $1.05 per barrel fall in crude.

French foods group Danone tumbled 7 percent after saying it planned a near 3 billion euro rights issue, and Rio Tinto fell 3 percent after agreeing with Nippon Steel to cut key iron ore prices by a third.

U.S. consumer confidence data is due later in the day.

The recent wobble notwithstanding, European stock markets are on track for their third successive month of gains, the first time in two years that they have had such a long winning streak. The 33 percent surge since March 9 has been powered by improving macroeconomic data and results from some big companies that have beaten analyst forecasts.

Year to date, mining stocks have risen by red-hot 38 percent, while banks, battered through 2008, have staged a handsome comeback with a 21 percent rise. Analysts said they expected profit margins to remain fairly resilient in this cycle.

Risks to the stock market rally could come from negative macro data. Underlining the fragile basis of the rebound, data showed that Germany’s economy contracted by 3.8 percent, a record pace, in the first quarter of 2009.

Around Europe:

FTSE     4,322.03    – 43.26    – 0.99%
DAX        4,827.16    – 91.29    – 1.86%
CAC        3,182.48    – 53.68    – 1.66%

Oil Below $60 Ahead of OPEC, Firmer Dollar Drags

Oil fell below $60 a barrel on Tuesday, pressured partly by a firmer U.S. dollar and expectations an OPEC meeting later this week would keep the producer group’s output unchanged.

U.S. oil prices [ 59.87    -1.80  (-2.92%)] for July delivery fell from Friday’s close.
London Brent crude [ 58.87    -1.34  (-2.23%)] was down.

Oil has nearly doubled in price since December, buoyed partly by expectations of higher prices if the world economy recovers.

OPEC’s most influential member Saudi Arabia said the group was likely to leave its output targets unchanged. The al-Hayat newspaper quoted Saudi Oil Minister Ali al-Naimi as saying world stocks were still too high to consider lifting output. OPEC will meet in Vienna on Thursday to review its supply policy.

Militant action in Nigeria has become a supportive factor for prices. Nigerian militants launched a major strike against the oil industry late on Sunday, bombing a Chevron pipeline and shutting 100,000 bpd of output.

Dollar Recovers as German Bank Doubts Knock Euro

The dollar strengthened broadly on Tuesday after a media report questioning the health of the German banking system prompted traders to trim back bets against the dollar that had driven it to a five-month low last week. Britain’s Daily Telegraph reported that Germany’s financial regulator BaFin had warned that toxic debt of the country’s banks would blow up "like a grenade" unless they took advantage of government bad-bank plans to prepare for the next phase of crisis.

The report was not new, however, as the regulator warned last week that German banks have bad assets of around 200 billion euros ($280 billion). Still, traders used it as an excuse to sell the euro and cash in on the currency’s rise of 8 percent in just a month against the dollar from $1.30 to $1.40.

The dollar index, a gauge of the greenback’s performance against six other major currencies, was up 0.4 percent on the day at 80.34.

The euro [ 1.3891    -0.0122  (-0.87%) ] fell against the dollar. On Friday it rose as high as $1.4051 on trading platform EBS, its highest since early January.

The euro [ 0.0075815    0.0001  (+0.77%)   ] lost more ground against the yen, while the dollar [ 94.89    0.08  (+0.08%)   ] fell against the Japanese currency.

Continental European markets were open on Monday, however, and Ifo think tank’s German business climate index fell short of market expectations, suggesting that any recovery in the euro zone’s biggest economy will take time. Figures on Tuesday confirmed that Germany’s economy shrank in the first quarter at its fastest ever pace since reunification in 1990, thanks to record falls in exports and investment.

Gold dips on firmer dollar, ignores N.Korea

Gold fell 0.5 percent to $953.10 per ounce from Monday’s notional close of $957.80, but just a whisker off the two-month high above $960 touched last week.

Gold markets showed little response to a report on Tuesday that North Korea would launch more short-range missiles.

The world’s largest gold-backed exchange-traded fund, the SPDR Gold Trust GLD, said its holdings were at 1,118.76 tonnes as of May 25, when the U.S. markets were closed, unchanged from May 22.

ETF Securities said the amount of metal it holds to back its physical silver exchange-traded commodities rose by 114,100 ounces on Friday and by 2.3 percent week-on-week to a record 19.576 million ounces.

Among other precious metals, silver was at $14.41 an ounce against $14.71, tracking gold. Platinum was quoted at $1,130 an ounce against $1,149.50 late on Monday, while palladium was at $230 against $231.50.

 Gold is getting crushed this morning. I’m seeing a BIG selloff starting around 3AM and it has been relentless. Down to $940 so far on the bid.     Yeeeeeouch that bites
News over the holidays was just dismall. Market is finally starting to show a direction (down) in line with the news and sentiment over the real economy. I’m starting to think last week was the top of the bear market rally. Maybe we will finally see the beginning of a selloff back down to retest the March low?  It would be a bear’s dream to finally have a tarde going with the current for a change.

Gold smashed, oil down,  futures pointing towards a lower opening, news bearish in MSM over the weekend.  What’s left to invest in?  Maybe treasuries?  I seem to remember an auction coming up here pretty soon.**
** – sarcasm for free!

Still time to get in to the USO put play this morning? If so,what looks good?

 China trapped?… interesting

In recent months, senior Chinese officials, including Premier Wen Jiabao, have repeatedly signalled their concern that US policies could lead to a collapse in the dollar and global inflation.
But Chinese and western officials in Beijing say China is caught in a "dollar trap" and has little choice but to keep pouring the bulk of its growing reserves into the US Treasury, which remains the only market big enough and liquid enough to support its huge purchases.

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