Interest rates have moved lower recently due primarily to the financial scare across Europe. The two-year Treasury is yielding a paltry 87 bps. Even out 10 years, Treasuries are yielding about 3.25%. What is an income investor to do? Well, the recent sell-off in equities, accompanied by the expansion of implied volatility, has presented some interesting dividend yield plays.
Let’s take Conoco-Phillips (NYSE: COP) as an example: The stock is trading at $50.50, and the company is currently paying out $2.20 per year in dividends. That is an annual dividend yield of 4.35%, far outpacing the yield of the two-year treasury. If you theoretically couple this with selling long-dated calls, things get really interesting. Assuming that COP keeps its payout steady at $0.55 per quarter, investors could buy the stock for $50.50, sell the November 55 calls for $2.25, and collect two $0.55 dividends. Let’s look at the cash flows assuming the stock does not move:
- Collect $1.10 in dividends
- Collect $2.25 in option premium
- Return is $3.35/$50.50 = 6.6% for about half a year. That is an annualized rate of more than 13%. This seems pretty good if you look at Treasury rates over that same time frame.
If the stock rallies, returns will be better.
Now, what about the risks: (more…)
As oil broke above $80 on Thursday, I went and looked at ConocoPhillips (COP) and Exxon Mobil (XOM). They are an interesting case study in two companies who basically do the same thing, but their debt levels change how their stocks behave. I thought this example was interesting because many times people think of COP and XOM interchangeably, when they actually have different characteristics.
