Shares of an elite Dividend Champion just broke above an important level of resistance…
Yesterday, Emerson Electric (EMR) — which was featured as Dave Van Knapp’s Dividend Growth Stock of the Month for March 2015 — burst through its “secondary downtrend resistance line” on solid volume.
In the process, it was able to close above its 20-day moving average.
While both of these are signs of a potential reversal, there’s still reason to be cautious.
In short, and what’s not pictured in the chart below, is yesterday’s candlestick that shows how the stock actually pierced both its primary downtrend line AND the 50-day moving average intraday, but ultimately failed to close above them.
Nevertheless, the positive divergence we’re seeing on the MACD suggests that the stock’s downtrend is weakening (even if it’s not yet over).
With all of this in mind, one way for long-term income-oriented investors to play the stock’s current setup is to simply buy shares at the market price, hold them, and reinvest their growing dividend.
Another way to play it would be through what I call a “10% Trade.”
As a refresher, a “10% Trade” is a conservative income-oriented trade that involves generating a 10%-plus annualized yield by selling either a covered call or a cash-secured put on 1) a high-quality 2) dividend growth stock 3) trading at a reasonable price.
At current prices, Emerson seems to meet all three criteria, making it an ideal candidate for one of these trades.
As an added bonus, the possibility that yesterday’s breakout could be the beginning of a reversal simply adds an additional margin of safety to our trade.
Now, if you’ve never sold options before, you may be uncomfortable with the idea of learning something new.
But if you’re looking to boost your income, and to do it safely, I really encourage you to take the time to understand how this all works.
Especially considering the income opportunity we have today with Emerson: In short, while the company’s quarterly dividends equate to a 3.4% annual yield at current prices — which is already a nice yield — a select “10% Trade” could deliver over 7x that income.
Here’s how I’m personally taking advantage of this opportunity…
Capturing a 25.6% to 25.8% Annualized Yield from Emerson
Yesterday, I bought 200 shares of Emerson for $57.44 per share and simultaneously sold two May 15, $57.50 covered calls for $1.62 per share.
There are likely two possible ways this trade will work out… and they both spell at least double-digit annualized yields on my $57.44 purchase price.
Scenario #1: EMR stays under $57.50 by May 15
If EMR stays under $57.50 by May 15 I’ll get to keep my 200 shares.
This is a critical point to understand, and it’s why I ONLY make these trades with stocks that 1) I’d like to own anyways and 2) that I believe are already trading at reasonable prices.
In other words, if I already like the underlying stock — and if I think it’s already trading at a reasonable price — then if I’m “stuck” holding shares at expiration (May 15) then that’s perfectly fine with me: I’ll simply collect a growing dividend while waiting for a new opportunity to sell another round of covered calls.
On the other hand, I’m not going to be too happy if I’m left holding shares of a stock I really don’t want to own or that I had paid too much for in the first place. So ONLY make these trades with stocks you’d be happy owning at the current price.
[hana-code-insert name=’adsense-article’ /]In this scenario, excluding commissions, I will have received $324 in covered call income ($1.62 x 200 shares).The covered call income — known as a “premium” in the options world — was collected instantly yesterday. It was deposited in the account where I made the trade.
At the end of the day, if “Scenario 1” plays out I’ll be looking at a profit of $314.47 after commissions.
On a percentage basis, I received an instant 2.8% yield for selling the covered calls ($1.62 / $57.44).
When I subtract out the commissions I’m looking at a 2.7% yield in 39 days… which works out to a 25.6% annualized yield. Again, not bad considering Emerson’s current forward dividend yield over the next 12 months is 3.4%.
Scenario #2: EMR climbs over $57.50 by May 15
If EMR climbs over $57.50 by May 15, my 200 shares will get sold (“called away”) at $57.50 per share.
In this scenario, I’ll have collected $324 in covered call income ($1.62 x 200 shares) and $12.00 in capital gains [($57.50-$57.44) x 200 shares].
After commissions, I’ll be looking at a profit of $317.02.
From a percentage standpoint, this “10% Trade” will deliver an instant 2.8% yield for selling the covered calls ($1.62 / $57.44) and a 0.1% return from capital gains ($0.06 / $57.44).
After subtracting out the commissions, I’m looking at a 2.8% total return in 39 days, which works out to a 25.8% annualized yield from EMR.
Bottom Line: As I’ve mentioned before, as long as the market continues to offer safe, income-generating opportunities like this one, I’ll be more than happy to take them. And I’ll continue to share these opportunities with you so you can see for yourself how they work.
Greg Patrick
TradesOfTheDay.com