People are afraid of what they don’t know, and even though this company is a well-proven large-cap blue chip, investors are unsure of it because it recently separated into a standalone company from another large cap blue chip. And because of this uncertainty, combined with near-term pricing pressures, investors are afraid. And we like that because it’s creating an attractive income opportunity in a big-dividend blue chip company with lots of cash that it is using to support the dividend, buyback shares and support the ongoing long-term success of the business. We believe this is an attractive trade to place today, and potentially over the next few trading days as long as the share price doesn’t move too dramatically before then.
The Trade:
Sell Put Options on Dow Inc (DOW) with a strike price of $50 (4.4% out of the money), and an expiration date of January 17, 2020, and for a premium of $0.35 (this comes out to +18% of extra income on an annualized basis, ($0.35/$50 x (52/2 weeks until expiration). This trade not only generates attractive income for us now, but it gives us the possibility of owning shares of DOW at an even lower price if the shares fall even further than they already recently have, and they get put to us (and we’d be happy to own DOW, especially if it falls to a purchase price of $50 per share).
Note: depending on how much upfront premium income you want to generate, and how much likelihood you’re comfortable with that the shares may get put to you before expiration, you might consider the $51 strike price, or even simply buying the shares outright.
Your Opportunity:
We believe this is an attractive trade to place today and potentially over the next few days as long as the price of DOW doesn't move too dramatically before then, and as long as you’re able to generate annualized premium (income for selling, divided by strike price, annualized) of approximately 12% to 15%, or greater.
Our Thesis:
Our thesis is basically that DOW is an attractive long-term, big-dividend (5.3% yield) Blue Chip company (it’s a member of the Dow 30) with price-appreciation potential, and the shares have sold off inappropriately this year (as you can see in the chart above). We recently completed a full write-up on DOW, and you can access it here:
We concluded that article by writing:
Post reorganization, the new Dow has emerged stronger and more focused. The company is set to generate significant levels of FCF over the near to medium term despite the current downturn in the macro economy. And despite strong FCF generation and a market leading position, the company’s shares offer an appealing dividend yield of 5.1% which provides investors with a strong risk-reward balance. If you’re looking for a healthy blue chip dividend, and mid to long-term price appreciation potential, Dow is an attractive opportunity that is still flying a bit under the radar (to many dividend investors) simply because it has newly reemerged as a standalone company following its recent reorganization.
Worth noting, DOW is a cash-rich company. Specifically, DOW is easily covering its dividend payments with cash flows from operations, and it has also been implementing share repurchases, another attractive practice for shareholders.
And making this trade even more compelling is the fearful short-term price choppiness particularly this year (2020). It has created an attractive opportunity to sell puts because the premium income available for selling put options is higher when uncertainty (volatility) is higher, as is the case currently.
Important Trade Considerations:
Two important considerations when selling put options are dividends and earnings announcements because they can both impact the price and thereby impact your trade. In this particular case, both are largely a non-issue. First, DOW isn’t expected to go ex-dividend until the end of February—after this options contract has already expired. And with regards to earnings, DOW isn’t expected to announce earnings again until January 30th (again after this options contract expires). Had either of these events happened prior to this option trade’s expiration, we’d have to take a closer look at the potential impacts on the trade.
Conclusion:
DOW is an attractive long-term big-dividend (5.3% yield) blue chip company, and the recent bout of volatility makes this income-generating options trade even more attractive. Specifically, the volatility makes the upfront premium income on this trade higher (volatility/uncertainty is the #1 driver of option premium income pricing). As noted earlier, in our full DOW report, we view Dow as presenting an attactive investment opportunity at its current price, however if you’re uncertain about pulling the trigger on a normal buy order, you might consider this trade instead. It’ll allows you to generate attractive upfront income that you get to keep no matter what. And this options trade also gives you a chance of picking up shares of this attractive long-term blue chip company at an even lower price, if the shares fall even further than they already have, and they get put to you at $50. And at a price of $50, DOW is an extremely attractive long-term cash flow generator.