Selling a Cash Covered Put for Dividend Capture or Short Term Income

As regular readers will know, I don't like selling naked, or uncovered, options. Here is an exception: Selling a cash secured put.

Let's talk dividends and how to sell cash secured puts as a way to generate income short term or capture above market dividend yields longer term. (Disclaimer Time: As always when I use a  real life example,  I am in no way, shape or form advising or recommending this or any other trade. That is solely for you to decide. My role here is entirely educational)

I like dividends. I firmly believe companies should return part of their earnings to their owners (ie the shareholders) as compensation for the risk taken in owning them. As opposed to stock buy backs, which I hate, but that's a whole different discussion.

At this writing only 47 stocks in the entire S&P 500 have a dividend yield in excess of 4%. This is largely due to the incredible run up stocks have seen (which fanatic and ideolgically driven Republicans seem hell bent on derailing). Remember, dividend yield has an inverse relationship to price. Here's an example: Let's take AT&T (T) . With an annual dividend of $1.80 T yields a very respectable 4.9% at today's price of 36.75. How can I sell cash covered puts to either get an even better yield or generate short term cash?

The January 2014 34 put (giving the put owner the right and not the obligation to sell T at 34) is trading at $1. Remember, each option represents 100 shares of stock. So, the right to sell 100 shares of AT&T at 34 costs $100. If T finishes below 34 I will be assigned on the put and take delivery of the stock at an effective price of 33 (34-1). At 33 T yields a whopping 5.45%. Pretty nice, eh? If, however, T never sees 34 the put expires worthless and I collect $100 per contract. Win win!

Caution! Remember I said "cash covered put". I must be willing and have the resources set aside to take delivery of  T at 34 in January. Let's say I have $34,000 that I want to invest in 1000 shares of AT&T if and only if the dividend yield is higher than 5%. I place the 34K in a liquid interest bearing asset such as a government bond. I then sell 10 January 34 puts at a price of 1, meaning I collect $1000.  If on the third Friday of January, 2014 (when the option expires) T is below 34 I use the 34K I've set aside and take delivery of 1000 shares (which I can then turn into a covered write by selling calls, but that's for another time). If T is above 34 the put has no value and the $1000 is mine.

So, we see you can sell puts either to capture good dividend yields or create short term income.The market is full of opportunities such as this. Feel free to contact me for more information or if you have any questions.