Well, another day goes by and I still have no clue where the market is headed.
At the time, my solution was a “10% Trade” with Cisco (CSCO). In short, it was an undervalued dividend-grower that:
1) I would be happy owning for the long-haul if the market were to tank (for its growing dividend), or…
2) I would be happy letting go of for a double-digit annualized profit if its price were to rise in a relatively short period of time. (If you’re curious how the trade turned out, go here.)
While I still don’t know the answers to these questions, I continue to believe that following a “10% Trade” script for a portion of my portfolio is a solid course of action.
Today, however, my security of choice for this kind of trade is McDonald’s (MCD).
Yesterday morning, when shares dropped below $100, I saw a fresh opportunity… so I jumped on it.
Capturing a 12.7% to 14.2% Annualized Yield from McDonald’s
Yesterday, at approximately 11:09am EST, I bought 100 shares of McDonald’s (MCD) for $99.96 per share and simultaneously sold one August 16, $100.00 covered call for $1.76 per share.
After commissions, this “10% Trade” immediately reduced my cost basis to $98.41 per share.
There are only two possible ways this trade will work out… and they both spell at least double-digit annualized yields…
Scenario #1: McDonald’s stays under $100.00 by August 16
If McDonald’s stays under $100.00 by August 16 I’ll get to keep my 100 shares.
In the process I’ll also have received $176 in covered call income ($1.76 x 100 shares).
The covered call income — known as a “premium” in options speak — was collected instantly yesterday.
If “Scenario 1″ plays out, after subtracting the commissions, I’m looking at a profit of $155.27 — or a 1.6% return in 40 days.
That may not sound like a heck of a lot, but it works out to a 14.2% annualized yield from McDonald’s. That’s quadruple the stock’s “regular” forward annual dividend yield of 3.2%.
Or look at it another way: I’m collecting 1/2 of the stock’s “regular” annual income (1.6% yield vs. 3.2% yield) in about 1/10 of the time (40 days vs. 365 days).
Scenario #2: McDonald’s climbs over $100.00 by August 16
If McDonald’s climbs over $100.00 by August 16 my 100 shares will get sold (“called away”) at $100.00 per share.
I’ll have generated $176 in covered call income ($1.76 x 100 shares) and $4.00 in capital gains ($100.00 – $99.96 x 100 shares).
In this scenario, after commissions I’ll be looking at a $139.28 profit.
From a percentage standpoint, after subtracting out the commissions this “10% Trade” will deliver a 1.4% total return in 40 days.
That works out to a 12.7% annualized yield from McDonald’s.
Bottom Line: Either way this “10% Trade” works out offers me the opportunity to generate a 10%-plus annualized yield from McDonald’s (MCD) – a high-quality, dividend growth stock that appears undervalued at current prices (My friend and colleague Jason Fieber pegs MCD’s “fair value” at $115.56). So if I get to keep my shares, compound my income, and “rinse and repeat” this process to continue lowering my cost basis, great. Or, if I’m forced to sell McDonald’s for a 12.7% annualized return, no problem. This is why I’m such a fan of “10% Trades”… and why I’ll continue to take advantage of them to boost my income regardless of which direction the market could be headed.
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