If you are an income-focused investor, you may want to consider the yield boosting options trade in this report. It’s a strategy that some investors repeat often, and in this particular instance we are focused on a high-income energy-sector investment that offers a 7.5% yield (paid quarterly), and this trade adds significantly to that amount. We believe this is an attractive trade to place today, and potentially over the next few trading sessions, as long as the price of the underlying security doesn’t move too dramatically before then.
Overview: Enterprise Products Partners (EPD)
The trade we will review (in a moment) is to sell “covered calls” on Enterprise Products Partners (EPD). If you don’t know, EPD operates one of the largest integrated networks of midstream infrastructure for natural gas, natural gas liquids (NGL), crude oil, petrochemical and refined products in the US. We recently completed a very detailed report about the attractiveness of owning EPD back on February 16th, and you can read that full report here. Since that time, the share price is up nearly 10%, and if you count the quarterly distribution we’re up nearly 12% (we do currently own EPD within our Income Equity portfolio).
The Trade:
Sell “Covered” Call Options on EPD with a strike price of $25 (~3.9% out of the money, it currently trades at ~$24.07), and an expiration date of June 16, 2021, and for a premium of at least $0.08 (or $8 because options contracts trade in lots of 100). This comes out to approximately 0.33% of extra income in just 16 days—which may not sound like a big return—but it is a lot for such a short time frame (it’s over 7.5% of extra income if we “annualize” this number, calculated as ($0.08/$24.07) x (365/16) days).
An important part of this trade is that you must own shares of EPD (this is the “covered” part of the trade). By owning the shares, you reduce the uncertainty risk of the trade (for example, if the shares do get called away from you within the 16 day period, you don’t have to go out and buy them at the market price—because you already own them).
And if the shares do get called away from you, it will be at a 3.9% gain for you (they currently cost $24.07 and the call price is $25). In aggregate, if the shares get called away from you before expiration, you get the $0.93 gain ($25 - $24.07) plus the $0.08 premium income. You basically get an extra $1.01 ($0.93 + $0.08) in just 16 days for placing this trade.
And another great part of this trade is that EPD is an attractive long-term investment if the shares don’t get called away from you, so you can feel comfortable continuing to hold the shares (as we wrote in our earlier full report on EPD, linked earlier). Remember, this one offers an additional 7.5% yield for long-term investors (through its normal quarterly distribution payments), and importantly that quarterly distribution hits your account after this options trade has expired, so it doesn’t much anything up with this trade (i.e. the ex-dividend date for EPD isn’t until late July—well after this trade has expired).
Your Opportunity:
We believe this is an attractive trade to place today and through the rest of this week, as long as the price of EPD doesn't move too dramatically before then and you’re able to generate enough premium income to your liking. Importantly, you should also be comfortable owing EPD for the long-term in case the shares do not get called away from you (we currently own shares of EPD in our long-term Income Equity portfolio).
Our Thesis:
Our thesis is simply that EPD is an attractive income-paying security, and this trade allows you to boost your yield on the position. In theory, EPD shares should be less volatile than other energy sector plays because of the steady nature of its long-term midstream contracts with clients. However, the business is still supported by strong energy demand as the economy re-opens, and it increases our confidence in this trade. If the shares get called away between now and the expiration date in 16 days—that’s fine (we’ll have generated a nice gain), and if the shares don’t get called away—that’s fine too (we’re left holding an attractive long-term income-paying security).
Important Trade Considerations:
Two important considerations when trading options are ex-dividend dates and earnings announcements because they can both impact your trade. In EPD’s case, neither is a concern. EPD isn’t expected to announce earnings until July 30th—well after this trade has expired. And EPD isn’t expected to go “ex-dividend” until the end of July—also well after this trade expires. Had either of these events taken place before option expiration, it would add uncertainty to this trade, and we’d have to receive higher premium income to account for this uncertainty. However, we are very comfortable with the income this trade generates, and we are comfortable with the overall trade.
Conclusion:
Overall, EPD is an attractive high-income investment. And the covered call option trade described in this report effectively boosts the high income EPD provides in its own right. If the shares of EPD get called away from us before the contract expires—that’s great because we will have generated a strong profit. And if the shares don’t get called away—that’s great too because we will have successfully boosted the high income this security already provides to us. Overall, we believe this is an attractive trade to place today, and potentially through the end of this week, as long as the price of EPD doesn’t move too dramatically before then.