Lorillard: Short-Term Volatility Creates Great Opportunity For Dividend Investors

| About: Lorillard, Inc. (LO)

Lorillard (NYSE:LO) has to be one of the most volatile dividend stocks in the market has ever seen. While today Lorillard shares are now at their 52-week high, just a year and a half ago this stock was bottoming out in the mid-$70s amid rumors that menthol cigarettes might be banned by the FDA.

Given that Lorillard derives over 90% of its revenues from menthol brands, even the slightest concern of this doomsday scenario was frightening to traders and investors.

Today the issue of whether or not the FDA is seriously considering a menthol ban is all but over. The FDA has not only refused to ban menthol, but recently refused to issue any commentary suggesting that menthol is more harmful or likely to cause addiction than any other standard form of flavoring in tobacco products.

As concerns over an FDA ban of Menthol have come down, so to has the short-interest in the stock. While over 10% of Lorillard's float was short just a couple months ago, today, only around 4% of the float is short.

However, well concerns over a menthol ban have come down and the stock is much less volatile than it was a year ago, current volatility levels in Lorillard's share remain elevated. The short-interest in Lorillard's shares of around 4% is still nearly 5x that of the company's tobacco peers, Reynolds (NYSE:RAI) and Altria (NYSE:MO). Lorillard, a nearly $18 billion company, is also significantly smaller than the nearly $65 billion Altria, or the nearly $24 billion Reynolds, and has a smaller number of available shares outstanding as well.

So, what does this mean for investors? Despite Lorillard's recent 20% dividend raise, the stock's significant outperformance of its larger peers, and the company's continual ability to defy the industry with consistent market share gains, shares are still volatile.

While few serious investors fear a menthol ban, given the recent FDA developments I have discussed at length in previous articles, Lorillard's shares still move around 3-5% a day. The reason for this is that Lorillard is still a small company with a market capitalization of around $18 billion, and a small float.

This sets up a great opportunity for traders or investors who are seeking stabile income. A traditional investor can buy Lorillard shares today at around $138 and sell a May $140 call trading at the 140 strike for $2. This enables a trader or investor to take in income of around 1.5% a month, still have about 2% upside in the share price a month, and collect the nearly 4.5% annual dividend as well. This trade or investment strategy sets up a 12-15% annual return. Obviously the risk is that Lorillard shares decline more than the premium collected from selling the call in a given month.

To conclude, Given that Lorillard's valuation at around 14x an average estimates of next year earnings estimates, the stock continues to yield around 5%, and interest rates remain very low, a significant near-term pullback in the company's shares seems unlikely. With the S&P 500 and its exchange traded fund SPY (NYSEARCA:SPY) up nearly 30% for the year, and stocks like Apple (NASDAQ:AAPL) up nearly 40% this year, stabile investments that can generate moderate to significant income should be of greater appeal if the market consolidate over the next couple months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.