It's been a rough couple of months for the price of oil, and that has dragged down the how energy sector with it.
With oil off nearly 20% from its recent peak in April, the energy sector (XLE) is now firmly in correction territory.
Now, it could get a little worse before it gets better. But many of these energy stocks are starting to look really attractive from both a yield and valuation perspective.
Although these stocks are probably good long-term purchases at current levels, we believe the sector is setting up very nicely for a cash-secured put strategy, which offers a much better risk-reward trade-off if oil has yet to bottom.
In addition, given the recent volatility in the space, energy stock put options have some extremely juicy premiums right now. That will allow us to generate income yields well in excess of the already-attractive dividend yields.
By selling a cash-secured put, you have an obligation to purchase the stock at a predetermined price (strike price) on or before the expiration date if the buyer of the put option wants to sell you the stock. However, the put seller gets to generate income while mitigating downside price risk. Cash-secured puts essentially act as a limit order for dividend stocks you want to add to your portfolio - but you get paid to put the order in!
3 Energy Dividend Stocks to Consider Now
Below are a few examples of high-quality energy dividend stocks that are currently on our watch list to purchase. But why buy when you can get paid to wait?
As you can see, a few of these stocks are currently trading well below their relative Buy Zones, but that is typical of the energy sector. (This also makes it hard to time the bottom.) That gives you all the more reason to play it safe with cash-secured puts instead.
Exxon Mobil (NYSE:XOM) is certainly the least volatile blue-chip of this group. It pays a solid 4.7% dividend yield and has been a true dividend aristocrat, having raised its dividend for over 30 years. That said, the stock is currently trading just above our Buy Zone of $69.00-$73.00.
As a result, the July 19 $70.00 strike cash-secured put is an attractive alternative to buying the stock at current levels.
This trade would give you a $69.20 breakeven price (i.e., net purchase price if exercised), a margin of safety of 6.0% below the current price, and a premium yield of 1.2% in just 44 days! This equates to a 9.5% annualized yield (2.0x XOM's annual dividend yield) without the need to purchase the stock.
Marathon Petroleum (NYSE:MPC) pays a respectable 4.4% dividend yield and has a good recent track record of raising its dividend. That said, the stock is currently trading well below our Buy Zone and 45% below its 52-week high. We need to be careful not to catch a falling knife here.
The July 19 $42.50 strike cash-secured put, therefore, is an attractive alternative to buying the stock at current levels.
This trade would give you a $41.87 breakeven price (i.e., net purchase price if exercised), a margin of safety of 13.7% below the current price, and a premium yield of 1.5% in just 44 days! This equates to a 12.3% annualized yield (2.8x MPC's annual dividend yield) without the need to purchase the stock.
Occidental Petroleum (NYSE:OXY) pays a very attractive 6.3% dividend yield and also has a good recent track record of raising its dividend. That said, the stock is currently trading well below our Buy Zone and 43% below its 52-week high. This is another potential falling knife situation.
As a result, the July 19 $45.00 strike cash-secured put is an attractive alternative to buying the stock at current levels.
This trade would give you a $44.34 breakeven price (i.e., net purchase price if exercised), a margin of safety of 10.8% below the current price, and a premium yield of 1.5% in just 44 days! This equates to a 12.2% annualized yield (1.9x OXY's annual dividend yield) without the need to purchase the stock.
In the current market environment, a cash-secured put strategy is a great high-yield cure for the cautious dividend stock investor, especially in the volatile energy sector. As you can see from the examples above, with this strategy you can generate more income vs. that from buying the stock and collecting the dividend, and it gives you a nice built-in margin of safety: more income with less risk.
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Disclosure: I am/we are long XOM, MPC, OXY. 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.
Additional disclosure: The information contained within this article is for informational and educational purposes only and it is not intended as a recommendation of the securities highlighted or any particular investment strategy; nor should it be considered a solicitation to buy or sell any security. The strategies and securities mentioned in this article may not be suitable for all types of investors and the information contained in this report does not constitute advice. Past performance is not a guarantee of future results. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker.