3 Safe Dividend Plays For Q1 2019

Includes: AGNC, AM, AMGP, WSR
by: Damon Verial

With rising rates and the possibility of the market retesting December lows, I recommend traders and investors employ strategies with low downside risk.

Though rare, dividend arbitrage still exists through options, should you be able to locate put option with undervalued extrinsic value and add extra income generation via short options.

I recommend three high-yield dividend stocks on which to play a relatively low-risk dividend income strategy.

After researching the idiosyncrasies of this earnings season in my newsletter, I have become a bit more bearish. While I previously - and to an extent still do - held that the market will rally from the December pullback, hitting a new all-time high sometime Q1 or Q2 2019, I am increasingly considering the possibility that the market is set to enter a bearish phase earlier than I had expected (Q3 or Q4 2019). Right now, we sit at a pivotal point: Will the market continue to rally, recovering its losses and hitting a new peak - or will we see it retest December lows?

My data shows support for both sides. Thus, our best course of action for now is to watch and act carefully. Because of this, I am recommending low-risk strategies until the market either rallies past its 50% retracement of the previous pullback or until the market retests its December lows.

One such strategy is a sort of take on dividend arbitrage. We seek high-yield dividend stocks, buy them before the ex-dividend date, add an options strategy, and walk away with a profit. Whether you want to play this strategy as a short-term trading method or you are currently holding one of the high-yield dividend stocks tagged in this article and want some extra profit, this strategy can help you morph the suboptimal risk/reward profile of the current market in your favor.

These particular plays were chosen based on their yields, option prices, and closeness of ex-dividend dates. All are playable with this strategy in the coming weeks. This article can be treated as educational, for your future dividend trades/investments; or it can be treated as mere trade recommendations.

AGNC Investment Corp. (AGNC)

Since 2014, AGNC has delivered monthly dividends to its investors. The dividend yield is roughly four times that of the general market. This is in spite of the company having cut dividends multiple times in the past.

(Source: Simply Wall St)

As a mortgage REIT (investing in mortgage securities, not physical property), AGNC could face more cuts in the future. The reason for this is the increase in interest rates, which reduces a REIT's ability to grow. REITs must distribute at least 90% of their taxable income, leaving them to seek capital generation via loans which grow expensive with rising rates.

However, mortgage REITs have grown in environments of increasing rates, though this is not common. During rising rates, mortgage REITs fall an average of 4% per year. Still, during bear markets on the back of rising rates - the type of market I believe we are heading into - mortgage REITs tend to outperform the general market. Regardless of your stance of the general market and the future of the Fed's interest rates, the threat to a mortgage REIT's dividend is still present, as REITs typically raise capital via secondary offerings, leading to more dividend payments. AGNC has been rather conservative with secondary offerings but has recently ramped up its sales of new shares:

(Source: Damon Verial: data from ADVFN)

Ignoring the macro environment for a second and looking to artificial intelligence for where AGNC is headed, I find a median 9.9% gain predicted, via pattern recognition, over the next half year. The pattern is a bit messy, but the general idea is that a parabolic trend precedes a rally, which then slows into another parabola, repeating thereafter:

(Source: Damon Verial; data from Yahoo Finance)

The daily pattern is also bullish. My Markov chain model predicts an average daily movement of 5 cents per day. Down gaps and black candlestick days are the best times to buy, with the former giving the best average gains and the latter giving an 80% probability of a higher open the next day (see below; numbers represent probabilities of moving from one state to another):

(Source: Damon Verial; data from Yahoo Finance)

The stock goes ex-dividend on January 30. Earlier this month, AGNC announced its standard monthly dividend, relieving investors who were worried about a possible dividend cut. However, January 30 is also its earnings date; I am predicting an earnings rally (minus the dividend) on that day and can write a more in-depth earnings analysis in Exposing Earnings if requested.

Here is the play:

  1. Buy 1 lot stock
  2. Sell 15x Feb. 15 $22.50 puts
  3. Buy 5x March 15 $25 puts
  4. Buy 1x March 15 $30 call

The stock gives you exposure to the dividend. The call gives you exposure to the potential rally. The diagonal put spread gives you a net credit and helps protect you from a loss due to earnings or the dividend payout, provided the stock does not fall significantly below $22.50.

You can keep the short puts open for a second play of this type. This is what differentiates this play from a standard ratio spread; you can save on commissions by using the same short puts while reopening the long puts for the next month's dividend. If you feel $22.50 is cutting it too tight, consider the $20 puts; just sell in a higher ratio than this play's 3:1.

Just be aware that the lower the strike price, the more margin required. Ignoring the long call and stock position, the put spread achieves maximum gains at the short put's strike. Thus, lowering the strike forces the stock to move downward to a greater extent for you to achieve maximum profit.

Close the call after earnings/dividends. Close the stock position after earnings/dividends unless you plan to hold this stock long. Close the long puts after earnings/dividends. Close the short puts after earnings/dividends unless you plan to repeat the trade next month.

Whitestone REIT (WSR)

If you are looking for a high-yields REIT but worried about rising rates, WSR is a strong choice. It offers a yield of over 8%, which is generated by its investment in "e-commerce resistant" shopping centers across the Sun Belt. As an equity - not mortgage - REIT, it has the statistical profile of rising in environments of rising rates, returning an annual ROI of 10%.

WSR's industry has a moderate beta with the market and a high beta with yields. This is the only type of REIT that has a beta higher than the average REIT in respect to both the market and yields:

Description: https://static.seekingalpha.com/uploads/2018/4/1723581_15235000863872_rId45.png

(Source: Hoya Capital)

This is the more conservative choice of the two REITs in this article, especially considering the ex-dividend date and the earnings date for WSR are separate. This allows us to play a lower-risk pre-dividend options strategy. Here, we will be generating income by capping gains, which we didn't do on AGNC due to it reporting earnings.

WSR goes ex-dividend on February 1. Here is the play:

  1. Buy 1 lot stock
  2. Sell 1x March 15 $17.50 put
  3. Buy 2x March 15 $15 put
  4. Sell 1x March 15 $12.50 call

The stock aside, this options strategy requires no upfront payment. When the stock drops over $1 after the dividend payment, the long puts and short call will create profit. The stock will deposit the dividends.

After receiving the dividends, you can close the whole position. If you plan to hold the stock for the long term, just close the long puts and short call.

Antero Midstream Partners (AM)

This company has been growing dividends so consistently that analysts expect a yield of 15% and dividend per share (DPS) of nearly $4 in the next five years. It is already offering double the yield of the average oil industry:

(Source: Simply Wall St)

While the stock is not led by the dividend, the dividend increases are stable. This means you can capture a high yield by leveraging this erratic stock in buying at low points. This is perhaps the best long-term hold of the stocks in this article:

(Source: Damon Verial: data from ADVFN)

The dividend is fully covered by income, to boot:

(Source: Damon Verial: data from ADVFN)

Regardless, our focus here is capturing the dividend. In addition, AM will soon be taken over. To continue trading AM, you will need to switch to Antero Midstream (AMGP), whether by buying-and-selling or via the related paperwork after the takeover.

AM expects to growing its production even at stable oil prices. However, oil prices are on the rise. The current yield is nearly 8%, so let's attempt to capture this next payment.

For now, our focus is playing this before January 31, which is AM's ex-dividend date. Do keep in mind that the expected annual earnings growth is 24%. You might consider using this trade as an entry point into a long-term holding:

(Source: Simply Wall St)

Here's the play:

  1. Buy 1 lot stock
  2. Buy March 15 $25 put
  3. Sell March 15 $22.50 call

The stock will bring in dividends. The put will gain by the drop in stock price after the dividend. The short call will bring in nearly guaranteed income.

For a trade, close everything after the dividend payment. For a long-term holding, shift to just holding the stock by closing the option positions. The extrinsic value of the puts is currently less than the expected fall in the stock post-dividend, making this an arbitrage play.

Happy trading!

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.