The 3 Best Dividend Stocks To Sell Covered Calls Against

Includes: BP, LO, MSFT
by: The Independent Investor

Wow, the market is going straight down. While the S&P 500, and its tracking exchange traded fund, SPY (NYSEARCA:SPY), is up nearly 20% from the summer lows, the S&P 500 and most of the broader indexes have sold-off hard over the last month.

With deteriorating economic data and concerns over Europe's fiscal woes rising again, many investors are selling cyclical companies.

Still, while most of the broader indexes have sold-off hard, not all sectors have sold-off significantly. With the 10 year Treasury yielding less than 2% and rate likely to remain low for some time, it is unsurprising to see dividend stocks outperforming the broader indexes by a fairly wide margin once again.


However, while dividend investors generally have not seen their stocks decline significantly in last month, volatility premiums in the options market have still become elevated for a number of strong companies with high yields.


Microsoft (NASDAQ:MSFT) has had trouble growing in the past because of the company's strong market share and poor recent product launches, but the company's new Windows 7 launch was very successful, and Microsoft's planned Windows 8 launch should position the company well the benefit from the growth in the tablet and mobile phone market.


Microsoft is not traditionally known as a high yielder, but the company pays a dividend today of nearly 3%, and management has increased the dividend by 25% in the last 2 years.

Microsoft has nearly $60 billion in cash on its balance sheet and the company is generating over 20 billion a year in free cash flow. Microsoft's dividend payout ratio is only 26%, and the company has grown at an average of over 10% over the last 5 years. The stock currently trades at around 10x an average estimate of next year's likely earnings.

Microsoft's stock is volatile because the company is perceived as being more cyclical since its earnings are obviously tied to PC demand. Still, the company's strong reoccurring revenues and high market share have enabled its business model to hold up very well during periods of uncertainty. Companies such as Intel (NASDAQ:INTC) have also made bullish recent comments on PC demand.

Microsoft investors can today purchase the company's shares for around $28.50, and sell a June 29 dollar call option that expires in two weeks for 44 cents. This enables a trader or investor to take in a nearly 1% a month in premium, and only risk being called away from their position if the stock rises more than 3% in less than 2 weeks.


BP (NYSE:BP) has had a lot of recent legal troubles, but the company recently settled with most civil plaintiffs for around $7.8 billion, and the federal government has recently taken the company's gulf refinery unit off of criminal probation. Permits in the gulf are also being approved at a faster rate than in previous years, and BP has sold very few of its deep water assets.


BP pays a nearly 5% dividend today, the company recently raised its dividend by 15%, and the company's payout ratio of 16% is far less than its historically payout ratio of 40%. BP has nearly 14 billion on its balance sheet, and the company is generating over 11 billion a year in free cash flow. BP's larger peers, Exxon-Mobil (NYSE:XOM), and Chevron (NYSE:CVX), payout a significantly higher percentage of these company's revenues in dividends. BP shares trade at less than 6x an average estimate of next years likely earnings.

While BP's shares have obviously been volatile because of the recent drop in the price of oil and fears the government may pursue a large lawsuit against the company, oil prices are still strong today, with WTI at $86 dollars a barrel, and Brent at $101 a barrel. Oil prices have rebounded strongly from previous sell-offs, and geopolitical uncertainty in Middle East continues.

A trader or investor can purchase BP shares for around $36.50 today, and sell a June 38 dollar call for around $.40. This enables a trader of investor to collect nearly 1% in monthly premium while collecting the 5% a year dividend, and having nearly 4% upside in the stock near-term.


Lorillard (NYSE:LO) is a tobacco company with a nearly $16 billion dollar market cap that has consistently raised its dividend by 25% the last two years. Lorillard is much smaller than Altria (NYSE:MO) and Reynolds (NYSE:RAI), the company's two larger competitors, and has less than 15% of the tobacco market today.


Lorillard is the only major U.S. tobacco company that has minimal debt and is showing consistent increases in market share and annual cigarette shipments. The company's new maverick cigarette has been very successful, and a recent poor earnings report was largely due to wholesalers trade inventories that most analysts believe was a quarterly issue.

Lorillard's payout ratio of nearly 70% is lower than the company's two larger peers, and the company has over 2 billion in cash on its balance sheet in addition to over a billion a year of free cash flow. Lorillard trades at around 13x an average estimate of next years likely earnings.

Lorillard's shares are more volatile because the $16 billion dollar company has a small float, and a higher than normal short position of around 4%. Shorts took a strong position in the stock ahead of a recent FDA statement that some thought might ban menthol, which is the flavor Lorillard uses in its cigarettes, but the FDA has recently stated that the agency has no intention to ban menthol whatsoever.

A trader or investor can purchase Lorillard's share for around $121.00 and sell a June 125 call option for a $1.00. This enables a trader or investor to take in a nearly 1.5% premium a month, and still have upside of around 4% in the stock, and also collect the nearly 5% dividend.

To conclude, many dividend paying stocks have held up very well during the recent market decline. Still, option premiums have still become elevated as fear and volatility levels have risen. While, the market may consolidate or move lower for some time, patient trader or investors may find selling covered call against strong companies with high dividend payouts a safer way to collect income and stay long.

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