Verizon (NYSE:VZ) and AT&T (NYSE:T) are the two largest telecommunications companies in the United States. Both of these stocks have dividend yields of approximately 4.75%, which represent attractive payouts in this low interest rate environment. However, using a simple options strategy, investors who do not yet hold one or both of these companies in their portfolio can generate a yield of more than 5% from either of these stocks.
Verizon's quarterly dividend is equal to $2.31 per year. Based on a share price of $48.62, the current yield is 4.75%. Assuming the dividend does not change, an investor would have to purchase shares at $46.20 to achieve a 5% yield on cost. As you can see from the chart below, it has been more than a year since one could buy Verizon shares with a dividend yield of greater than 5%:
AT&T's annualized dividend is $1.96 per share. At its current share price of $40.28, the current yield is 4.86%. Based on this dividend rate, shares only need to fall slightly more than a dollar to $39.20 to deliver a 5% yield. Unlike with Verizon, AT&T has offered a 5% yield fairly often during the last three years:
Instead of simply waiting and hoping for a market correction or for a spike in interest rates to cause a pullback in these higher-yielding telecom stocks, investors can be proactive by writing cash secured put options.
A cash secured put is an option strategy in which an investor sells an out of the money put (with a strike price below the current stock price) and sets aside enough cash to pay for the stock if the share price falls below the strike price and the option is exercised.
The Execution - Verizon
In the case of Verizon, to achieve a yield of greater than 5%, an investor should be looking to purchase shares at less than $46.20 (as outlined above). Looking out at the option chain, we can see that put options expiring in July (approximately 3 months) with a $45 strike price are currently trading at 60 cents.
So an investor could sell one of these put option contracts (equal to 100 shares), put aside $4,500 in cash and collect $60 in option premiums. This is an effective yield of 1.3% over a 3 month period (or approximately 5.3% on an annualized basis). If Verizon shares are not trading below the $45 level in mid-July when the options expire, you can simply repeat the strategy by selling more cash secured put options 3 months into the future.
However, if Verizon's shares have fallen below the $45 level, you will be forced to purchase them using the $4,500 cash you set aside. At this price, the dividend yield of the shares will be 5.13% and you still keep the original $60 in option premiums.
The Execution - AT&T
The basic strategy is the same for AT&T, but the numbers are of course slightly different. The option chain for July shows that put options with a $38 strike price last traded hands for 54 cents each.
Implementing the cash secured put strategy at the $38 strike price means setting aside $3,800 in cash and collecting $54 in option premiums (equal to a 1.4% yield over 3 months or 5.6% annualized).
If the options are exercised at expiry, you would be buying AT&T for $38 per share and your dividend yield would therefore be equal to 5.15%.
Obviously, selling options can be a risky strategy. In either of these scenarios, if the stock price of the underlying security falls significantly for any reason, you will suffer meaningful "paper" losses by being forced to buy the stock above its current market price.
Therefore, this strategy works best with companies that you have full confidence in. Specifically, one needs to be 100% confident in the sustainability of the firm's dividend if the goal of this strategy is to generate above average levels of income.
There is also an additional, but less obvious risk: If the stock price of the company in question rises significantly and the options are not exercised, one is forgoing the potential capital gains by writing put options instead of simply buying the stock.
This strategy requires patience - more patience than the average retail investor possesses. Nevertheless, if you find a high-quality dividend-paying stock that looks attractive to you, but you would like a slightly lower entry point to boost your initial yield, consider trying the cash secured put route.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.