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Dividend Yield & Covered Calls

05/04/2020 9:38 am EST

Focus: OPTIONS

Alan Ellman

President, The Blue Collar Investor Corp.

When is it right to use dividend yield as a factor in covered call writing, asks Alan Ellman.

Combining covered call writing premiums with high dividend yields can be an enticing investment approach. In October 2019, subscriber Gerry wrote to me about using MPLX LP (MPLX) in her option-selling portfolio and pointed to the generous dividend yield and real-estate component as the reasons for this consideration. In the BCI methodology, we use fundamental analysis, technical analysis and common-sense principles (like minimum trading volume) to select our underlying securities. I would consider dividend yield as a secondary consideration or icing on the cake. Here, we evaluate the pros and cons of including this security in our portfolios as of October 2019.

 Annual dividend yield as of October 2019

MPLX
Source:  www.dividendinvestor.com

An annual yield of nearly 10% can be quite appealing but we haven’t investigated the three screening factors so important in our BCI methodology. Let’s focus in on the price-performance of this security over the past year.

Comparison chart of MPLX with the S&P 500

S&P MPLX
MLPX vs. S&P 500 six-month comparison

With the S&P 500 virtually flat over the previous year (+0.6%), MPLX was down nearly 20%. In this context, the dividend yield no longer seems attractive. One of the reasons a stock may have an unusually high dividend yield is that the share price has declined substantially. A $2 dividend on a $50 stock has an annualized yield of 4%. If share price drops to $25, that $2 dividend now represents an annualized yield of 8%.

Discussion

Covered call writing is a strategy that generates a monthly (or weekly) cash-flow from option premium. The quality of the underlying security is critical to our overall success. Using dividend yield only will cause us to lose focus on the critical screening factors that will guide us to the highest level of success.

Overall, I consider dividend yield “icing on the cake” and not a primary consideration in security selection for our covered call portfolios.

One way to include dividend yield into our portfolios in a safer manner would be to consider the best-performing Select Sector SPDRs in our Premium ETF reports and the best-performing Dow Jones stocks in our Premium Blue-Chip Reports.  Our premium stock reports also show dividend information.

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