An Investment Proposal Designed for Good Dividend Yield and/or Generating Short Term Income

There’s Always an Option 

In this current climate with the stock market hitting new highs, bonds underperforming, interest rates near zero, gold and other commodities falling, there is a quest for both yield and safety. The following strategy combines both stock and options and is called the cash secured short put. The purpose is to generate above current level dividend yield or create short term cash flow.

A put option (each option is for 100 shares) gives the buyer the right, but not the obligation, to sell a stock at the strike, or exercise price. So, if XYZ is trading at 100, the owner of the 100 put has the right and not the obligation to sell XYZ at 100 regardless of where XYZ is currently trading. For this the buyer pays an option premium to the seller. In exchange for this premium the seller is obliged to take delivery of XYZ at 100 if assigned. In trader’s terms the buyer is long the put and the seller is short the put.

I am now going to specifically propose the following strategy using prices from November 18, 2013. I am proposing selling puts in AT&T (ticker symbol T).

T is a long-established, stable and conservative company. At this moment, with the stock at 35.54 it has a respectable dividend yield of 5.06%. Moreover, T has a 28 year unbroken history of raising its dividend.

(http://www.dividend.com/dividend-stocks/technology/telecom-services-domestic/t-atandt/), thereby making T an excellent conservative long term investment.

My proposal is to create an even better dividend yield and/or be paid for taking the risk of so doing. I propose selling puts in T with enough cash set aside to take delivery of T at the exercise price if assigned.

For smarter trades subscribe to Tradespoon!

At this writing one can sell the T January 2014 34 put at a price of .44, or $44 for every put sold. This requires the seller to buy T at 34 at any time up until the third Saturday in January 2014. Obviously, if T is above 34 at that time the seller will not be assigned and will instead collect the .44 (minus commissions).

If assigned, one will have bought T at an effective price of 33.56 (34 exercise price minus the premium received). At 33.56 T has a dividend yield of 5.36%.

This short put sale must be entirely secured by cash. Let’s say one sells 10 January T puts at .44 (representing 1000 shares). One must have in the account $34,000. If not assigned one collects $440 and can sell the next further out February put. One can do this all year long and, if never assigned, yield an approximate hypothetical yield of 15.00%.

If assigned, one must accept the still above market yield of 5.36%. However, one can then sell a call option in a further out month as way of lessening the price of purchase (33.56). A call option gives the buyer the right and not the obligation to buy the stock at the exercise price. For this the buyer pays a premium and the seller receives this premium for taking on the obligation to sell the stock at the exercise price.

For example, if assigned on the short January call one could sell ten 36 April calls. If assigned on the April call you make 2.46 or 7.30% plus the premium received. If not assigned the premium is collected and a further out call option may be sold.

What is the risk? One must be very comfortable with the original 5.36% yield if assigned. And one must be willing to tie up $34,000. If T drops more than 5.36% one starts losing money, albeit unrealized.

The cash-secured put is a conservative investment strategy designed to either secure an above current market dividend yield or generate short-term cash flow.

For smarter trades subscribe to Tradespoon!