A “10% Trade” can be a relatively safe way to generate 10%-plus annualized yields from some of the best companies in the world.
Take Dividend Champion Johnson & Johnson (JNJ)…[hana-code-insert name=’adsense-article’ /]Thanks to market volatility, shares have pulled back roughly 10% over the past three weeks.
In short, the stock is now trading below $99.87 — the price my friend Jason Fieber pegged as “fair value” back in July.
But instead of buying JNJ at the market price, a “10% Trade” could offer us the opportunity to collect safe, double-digit income while waiting to buy shares at a discount to what they’re currently trading for.
As I write, JNJ is selling for $97.01 per share and the December 20, $95 puts are going for $2.35 per share.
For the sake of simplicity, let’s say our “10% Trade” involves selling one of these puts. We’ll also exclude any trade commissions to help keep the math easy.
In short, there would only be two ways this trade could work out.
On one hand, we’d get to generate a 13.5% annualized yield from JNJ without even owning the stock. That’s nearly five times the stock’s “regular” annual yield of 2.8%.
On the other hand, we’d get paid $235 in cash, immediately, for the opportunity to buy JNJ at $95 per share (which is a 2% discount to what it’s currently selling for).
If you like safe double-digit income and the shot to own JNJ at a discount to its current price, then both of these options should be more compelling than simply buying the stock at the current market price.
Let’s take a closer look at each scenario…
Scenario 1: JNJ falls below $95.00 by December 20
If JNJ falls below $95 by December 20, we’ll be obligated to buy 100 shares at $95 per share. So we’ll need to set aside $9,500 for this trade.
In exchange for our agreement, we would be paid an instant $235 (100 shares X $2.35 per share).
This money would be deposited into our accounts immediately.
Taking this income into consideration, our cost-basis would drop to $92.65 per share ($95 – $2.35).
That’s a 4.5% discount to the $97.01 share price that JNJ is selling for as I write. And it’s 7.3% below Jason’s “fair value” estimate.
Scenario 2: JNJ stays above $95.00 by December 20
If JNJ stays above $95 by December 20, our put option contract will expire worthless and we won’t buy the stock.
However, we’ll have kept the $235 in income.
Taking that income into account, this works out to a 2.5% return on what our purchase obligation would have been ($2.35 / $95) in 67 days.
If we can repeat these results over the period of a year we could generate a 13.5% yield from JNJ without even buying shares.
I’m seriously considering making a “10% Trade” with JNJ in the coming days. If I do, I’ll be sure to share the details here in the pages of Trades Of The Day.