Note from Daily Trade Alert: The goal of our High-Yield Trade of the Week column is to show you how to safely boost your income from some of the best stocks in the world. It’s our sincere hope that you benefit from this service.
This week’s High-Yield Trade of the Week is with AT&T (T).
AT&T was recently highlighted by Dave Van Knapp as an opportunity for investors to capture a relatively safe 6% yield at a potential 17% discount. It’s also Jason Fieber’s Undervalued Dividend Growth Stock of the Week for the current week.
How safe is AT&T’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 78.
Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak.
With this in mind, AT&T’s dividend appears safe, with a dividend cut unlikely (you can learn more about Dividend Safety Scores here.)
This is great news for conservative investors looking for safe, high income.
Plus, the strategy I have in mind is designed to be safer than buying stock the “traditional” way.
It’s a strategy that I personally use in my retirement accounts (401k and Roth IRA), and one that’s engineered to pay 10%-plus annualized income from some of the best companies in the world.
In short, the strategy I’m talking about involves selling a cash-secured put or a covered call on a high-quality dividend growth stock when it’s trading at a reasonable price (which is typically at or below fair value).
In fact, I just made one of these high-yield trades with AT&T this morning… and I’m generating an 18.3% to 42.3% annualized yield.
With all of this in mind, the following setup is what we’re looking at as we go to press. It’s the same high-yield trade I made in my retirement account just minutes ago, shortly after opening bell.
High-Yield Trade of the Week:
Sell the December 15, 2017, $35 call on shares of AT&T (T)
As we go to press, T is selling for around $34.28 per share and the December 15 $35 calls are going for about $0.55 per share.
Our trade would involve buying 400 shares of T and simultaneously selling four of those calls.
By selling call options, we would be giving the buyer of the option the right, but not the obligation, to purchase our 400 shares at $35 per share (the “strike” price) anytime before December 15 (the contract “expiration” date).
In exchange for that opportunity, the buyer of the option would be paying us $0.55 per share (the “premium”) per option.
Because we’re collecting immediate income when we open the trade, we’re lowering our cost basis on the shares we’re buying.
That’s what makes this trade safer than simply purchasing shares of the underlying stock the “traditional” way.
With all of this in mind, there are two likely ways our High-Yield Trade of the Week would work out, and they both offer significantly higher income than what we’d collect if we relied on the stock’s dividends alone.
To be conservative, we don’t include any dividends in our calculations for either of the following scenarios. The annualized yields are generated from options premium and applicable capital gains alone. So any dividends collected are just “bonus” that will boost our overall annualized yields even further. Let’s take a closer look at each scenario…
Scenario #1: T stays under $35 by December 15
If T stays under $35 by December 15, our options contract would expire and we’d get to keep our 400 shares.
In the process, we’d receive $220 in premium ($0.55 x 400 shares).
That income would be collected instantly, when the trade opens.
Excluding commissions, if “Scenario 1″ plays out, we’d receive a 1.6% yield for selling the covered calls ($0.55 / $34.28) in 32 days. That works out to an 18.3% annualized yield.
Scenario #2: T climbs over $35 by December 15
If T climbs over $35 by December 15, our 400 shares will get sold (“called away”) at $35 per share.
In “Scenario 2” — like “Scenario 1” — we’d collect an instant $220 in premium ($0.55 x 400 shares) when the trade opens. We’d then collect another $288.08 in capital gains ($0.72 x 400) when the trade closes because we’d be buying 400 shares at $34.28 and selling them at $35.
In this scenario, excluding any commissions, we’d be looking at a $508.08 profit.
From a percentage standpoint, this scenario would deliver an instant 1.6% yield for selling the covered calls ($0.55 / $34.28) and a 2.1% return from capital gains ($0.72 / $34.28).
At the end of the day, we’d be looking at a 3.7% total return in 32 days, which works out to a 42.3% annualized yield from T.
Here’s how we’d make the trade…
We’d place a “Buy-Write” options order with a Net Debit price of as close to $33.73 ($34.28 – $0.55) as we can get — the lower the better. Options contracts work in 100-share blocks, so we’d have to buy at least 100 shares of AT&T (T) for this trade. For every 100 shares we’d buy, we’d “Sell to Open” one options contract using a limit order. I just made this trade with four options contracts, so the numbers in this article reflect that. Accounting for the $220 in premium we’d collect for selling four contracts, that would require a minimum investment of $13,491.92.
P.S. We’d only make this trade if: 1) we wanted to own the underlying stock anyways 2) we believed it was trading at a reasonable price 3) we were comfortable owning it for the long-haul in case the price drops significantly below our cost basis by expiration and 4) we were comfortable letting it go if shares get called away. To be mindful of position sizing, except in rare cases, the value of this trade wouldn’t exceed 5% of our total portfolio value. In addition, to minimize taxes and tax paperwork, we would most likely make this trade in a retirement account, such as an IRA or 401(k).
Please note: We’re not registered financial advisors and these aren’t specific recommendations for you as an individual. Each of our readers have different financial situations, risk tolerance, goals, time frames, etc. You should also be aware that some of the trade details (specifically stock prices and options premiums) are certain to change from the time we do our research, to the time we publish our article, to the time you’re alerted about it. So please don’t attempt to make this trade yourself without first doing your own due diligence and research.