I Just Made This “10% Trade” with Pepsi (PEP)

[stextbox id=”info”]Please keep in mind that these “10% Trade” alerts are for information purposes only. We’re not registered financial advisors and these aren’t specific trade recommendations for you as an individual. Each of our readers have different financial situations, risk tolerance, goals, time frames, etc. The ideas we publish are simply ideas that we feel fit our specific needs and that we’re personally making in our own portfolios. You should also be aware that some of the trade details (specifically stock prices and options premiums) are certain to change from the time we make our trade to the time you’re alerted about it. So please don’t attempt to make this “10% Trade” yourself without first doing your own due diligence and research.[/stextbox]

As I mentioned last time, my colleague Phil Lamanna and I believe that “10% Trades” are one of the best ways to generate double-digit income from great companies.

In particular, we’re talking about an opportunity to capture 10%-plus annualized yields from stocks we wouldn’t mind holding for the long-haul — such as those with strong histories of increasing dividends year after year.

Names that come to mind are stocks like McDonald’s (MCD), Wal-Mart (WMT) and Pepsi (PEP).

[hana-code-insert name=’adsense-article’ /]As Dividend Champions, each of these stocks have showered shareholders with larger and larger dividend checks each and every year for at least the last 25 years in a row.

But even after decades of dividend growth, anyone putting new money into these stocks today will capture less than 3.5% yields.

That’s because over time their share prices have essentially risen in lockstep with their dividends, keeping dividend yields suppressed.

This can be a problem if you’re already in or nearing retirement and you’re looking for safe, high income from established dividend growers.

But this is precisely where a “10% Trade” can come in handy…

In short, a “10% Trade” is a term Phil and I coined for a conservative income-generating technique that involves selling either a covered call or a put on a high-quality dividend growth stock.

The beauty of a “10% Trade” is that you could double… triple… or even quadruple your annualized yields from the very same stocks I mentioned above… and many more like them.

It’s a great way to boost the yield on stocks you already own… or to lower your cost basis on stocks you’d like to own.

Consider the “10% Trade” I just made with Pepsi…

Capturing an 11.5% to 16.6% Annualized Yield from Pepsi
I like buying proven dividend growth stocks at reasonable prices. So when Pepsi (PEP) shares pulled back as much as 3% yesterday I pulled the trigger.

I won’t go into detail now as to why I’m ok buying Pepsi at these prices or why I consider it a stock I could hold for the long-haul.

Instead, I’d rather show you how this “10% Trade” can play out over the next 9 weeks.

That way you can see for yourself how simple and safe these kinds of trades can be.

Let’s get started…

"10% Trade" with Pepsi (PEP)

At around noon EST yesterday I bought 100 shares of Pepsi (PEP) for $79.08 per share and simultaneously sold the April 19, $80 covered calls for $1.25 per share.

There are only two possible ways this trade will work out… and the result should be at least a 10% annualized yield either way.

Scenario #1: Pepsi stays under $80 by April 19
If Pepsi stays under $80 by April 19 I’ll get to keep the 100 shares I just bought.

Pepsi (PEP)I’ll also have received $125 in covered call income ($1.25 x 100 shares) and $57 in quarterly dividends ($0.57 x 100 shares).

The covered call income — known as a “premium” in options speak — was collected instantly yesterday. I’ll collect the dividend income on March 31.

After commissions, the premium and dividend income alone will have already reduced my cost basis to $78.04 per share — a 1.3% “discount” on my purchase price yesterday. This, by the way, is a great example of how a “10% Trade” can be safer than a conventional stock trade.

At the end of the day, if this scenario plays out I’ll be looking at a $161.27 profit.

That may sound like peanuts, but take a look at the percentages: I received an instant 1.6% yield for selling the covered call ($125 / $7,908) and I’ll get a 0.7% yield from the upcoming dividend ($57 / $7,908).

When I subtract out the commissions, I’m looking at a 2.0% return in 65 days.

That works out to an 11.5% annualized yield… from a safe stock like Pepsi.

That’s the power of a “10% Trade.”

"10% Trade" with Pepsi (PEP)Scenario #2: Pepsi climbs over $80 by April 19
If Pepsi climbs over $80 by April 19 my 100 shares will get sold (“called away”) at $80 per share.

In this scenario, not only will I get to keep the $125 in covered call income ($1.25 x 100 shares) and the $57 in quarterly dividends ($0.57 x 100 shares)… but I’ll also generate $92 in capital gains ($0.92 x 100 shares) in the process.

Again, this is another example of the safety of a “10% Trade”: I’m getting paid now in order to agree to sell my stock at a higher price than what I just bought it for.

In this scenario, after commissions I’ll be looking at a $233.28 profit.

From a percentage standpoint, this “10% Trade” will deliver an instant 1.6% yield for selling the covered call ($125 / $7,908)… a 0.7% yield from the upcoming dividend ($57 / $7,908)… and a 1.2% return from capital gains ($80 / $79.08).

After subtracting out the commissions, I’m looking at a 2.9% return in 65 days (just over 9 weeks).

That works out to a 16.6% annualized yield from Pepsi.

Bottom Line: Either way this “10% Trade” works out offers me the opportunity to generate a 10%-plus annualized yield from a world class dividend grower like Pepsi (PEP). If I get to keep my shares and compound my income, great. If I’m forced to sell Pepsi at a 16.6% annualized profit, no problem. This is why I’m such a fan of “10% Trades.”

Greg Patrick

[hana-code-insert name=’SA-Max Income 3′ /]