Collar The ConocoPhillips Hefty Dividend

Feb.14.12 | About: ConocoPhillips (COP)

Sometimes you just feel good about a company and its stock and then you just noticed it pays also pays 3.62 percent in dividends. This would certainly grab my attention. Specifically, I am speaking of ConocoPhillips(NYSE:COP). The reason I like this stock fundamentally is because it is undervalued on every key metric. The forward p/e is just over 8.25 and its book value 49.56. The upcoming split-off of the Refining and Exploration is a positive for the stock.

Having said that, I believe the stock has a high probability of closing north of here by year's end. As such, I could take advantage of the high dividend payout of $2.64. One strategy I would consider is to buy COP stock and placing a protective collar on the stock through puts and calls. The collar requires selling a call and a buying a put as well. I prefer an at-the-money, or just out-of-the money call and buying a just out-of-the money put.

There are a couple of drawbacks involved with this strategy. First, if the stock really takes off you will not participate in the upside as you are "collared". Also, if COP does jump too soon too fast your short calls may be assigned prematurely thus stripping you of your stock and the dividends.

Some investors would question this strategy as they would prefer to just outright own the stock. I prefer to minimize my risks as any unforeseen event can sideswipe any thesis, no matter how bulletproof it may seem to be.

The analysis below demonstrates several scenarios using different variations of August options coupled with the purchase of stock.

Scenario I (Least Aggressive)
Purchasing 100 shares of COP stock @ 72.80, selling 1 Aug. 72.5 Calls @ 3.95 and buying 1 Aug. 70 Puts @ 4.20

At August Expiration
COP Price COP P&L Call P&L Put P&L Div* Tot. P&L
65 -$780 +$395 +$80 +$198 -$107
67.5 -$530 +$395 -$170 +$198 -$107
70 -$280 +$395 -$420 +$198 -$107
72.5 -$30 +$395 -$420 +$198 +$143
75 +$220 +$145 -$420 +$198 +$143
77.5 +$470 -$105 -$420 +$198 +$143
Click to enlarge

Scenario II (Aggressive)
Purchasing 100 shares of COP stock @ 72.80, selling 1 Aug. 72.5 Calls @ 3.95 and buying 1 Aug. 67.5 Puts @ 3.30

At August Expiration
COP Price COP P&L Call P&L Put P&L Div* Tot. P&L
65 -$780 +$395 -$80 +$198 -$267
67.5 -$530 +$395 -$330 +$198 -$267
70 -$280 +$395 -$330 +$198 -$17
72.5 -$30 +$395 -$330 +$198 +$233
75 +$220 +$145 -$330 +$198 +$233
77.5 +$470 -$105 -$330 +$198 +$233
Click to enlarge

Scenario III (More Aggressive)
Purchasing 100 shares of COP stock @ 72.80, selling 1 Aug. 75 Calls @ 3.00 and buying 1 Aug. 67.5 Puts @ 3.30

At August Expiration
COP Price COP P&L Call P&L Put P&L Div* Tot. P&L
65 -$780 +$300 -$80 +$198 -$362
67.5 -$530 +$300 -$330 +$198 -$362
70 -$280 +$300 -$330 +$198 -$112
72.5 -$30 +$300 -$330 +$198 +$138
75 +$220 +$300 -$330 +$198 +$388
77.5 +$470 +$50 -$330 +$198 +$388
Click to enlarge

*Dividend = $198 (3 x .66 Feb 16, Est. May 18, Est. July 20)

As the tables above illustrate, even with collars a trader can scale his or her risk. One could use any variation of options thereof to finer tune his/her risk tolerance.

On a final note, the company has stated its intention to continue to grow the payout, so a bump in dividend payout can further enhance this constructed trade.

Disclosure: I am long COP.