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AT&T (T) said on March 31 its quarterly dividend would stay flat t 27.75 cents as it has been in the past 4 quarters ($1.11 annually). We wrote about this on Feb. 13 in our article, “As AT&T May Not Hike Its Dividend, Covered Calls are Becoming Popular.” As a result, investors are turning to selling short out-of-the-money (OTM) puts to create higher income and also potentially lowering their buy-in costs.
At today's price of $19.25, T stock has a very attractive dividend yield of 5.76%. That could be one reason why management at AT&T decided to not raise the dividend after 4 quarters at the same level since the spin-off of Warner Bros. Discovery (WBD) last year and when it cut the dividend.
In addition, as I pointed out in my article on Feb. 13, the company needs the extra free cash flow (FCF) it is generating by keeping the dividend level in order to reduce debt. That is one reason why AT&T management talked about the “credit quality” of the “attractive” dividend being paid during the Q4 conference call.
For example, I showed that AT&T's free cash flow (FCF) dividend payout ratio was down to just 33% from 70% a year earlier. That means that there was more room left after deducting the stable dividend from FCF to cut the company's debt.
As a result, I wrote last time that investors could short out-of-the-money (OTM) calls, or covered calls, in order to gain an incremental amount of income. But now I think that investors are more interested in shorting OTM puts for additional income.
Shorting OTM Puts on T Stock
For example, right now the April 27 put option chain shows that the $18.00 strike price puts trade at 21 cents per put contract. That means that an investor who sells short the $18.00 strike price put will receive $0.21 per put option or a yield of 1.16%. This means that unless the stock falls by over 6% to $18.00 or below in the next 27 days, the option will expire worthless and the investor will have a clean return.
Moreover, as you can see above an even more conservative play is to short the $17.50 put contract for 15 cents. That means that an investor who secures $17,500 with their brokerage firm, can then enter an order to “Sell to Open” 10 put contracts for 1000 shares sold at $17.50. Immediately the account will receive $150 from the OTM short sale.
As a result, the investor's yield is 0.857% (i.e., $150/$17,500) for just 27 days. That is roughly equivalent to an annualized return of 10.3% if the same trade can be repeated each month. That is significantly better than the 5.76% dividend yield that long investors in AT&T stock presently are making. Moreover, the short put investor can potentially purchase the stock at a much lower price (i.e. the $17.50 or $18.00 exercise prices) if the stock falls to those levels.
And even if that happens, this would not be such a bad thing since the dividend yield would be significantly higher. For example, at $18.00 per share, the $1.11 dividend yields 6.17% and at $17.50 the dividend yield is 6.34%. This shows why shorting puts is a good long-term strategy in relation to owning AT&T stock.
In fact, some investors may want to not only own the shares of T stock at today's prices, as well as short OTM puts in near-term expiration periods. That way they get both a higher income play as well as the chance to lower their investment buy-in cost on a disciplined basis.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
