Devon Energy (DVN) stock has performed well with its present 3.88% dividend yield. Oil and gas prices have risen implying cash flow could be higher. Its fixed and variable dividend could be stable here.
Devon now pays a 20-cent quarter fixed dividend and a 29-cent variable dividend based on 50% of the quarterly adjusted free cash flow (FCF) after prior dividend payments. That puts the annualized dividend payment at $1.96 per share.
At $50.47 today, this gives investors in DVN stock a 3.88% annualized dividend yield. This, of course, assumes that the adj. FCF will hold up the same as in Q2.
Variable Dividend Could Be Sustainable
I discussed this situation in my recent Aug. 11, 2023, Barchart article, “Devon Energy's 3.87% Dividend Yield Attracts Investors And Short-Put Traders.” The company announced its dividend, which was lower than Q1 on Aug. 1.
At the time DVN stock was at $50.62, which shows that the price has held up well since the company declared its dividend. The reason is likely that investors see that oil and gas prices have held up well during Q3 so far. So, they might be hoping that Devon won't cut its dividend, or lower it by a small amount.
That makes its present dividend yield look sustainable. It also allows traders to make extra income by shorting out-of-the-money (OTM) put options.
Shorting OTM Puts for Extra Income
For example, the prior article suggested that shorting the Sept. 1 expiration $47.00 strike price puts might be worthwhile. That is because at the time the premium was 33 cents with just 21 days until expiration.
Today, those puts are much lower at just 6 cents per put option at the $47.00 strike price. That means that the short-seller has made much of the profit expected from going short those puts.
It might make sense to buy those puts back by entering an order to “Buy to Close.” Then the trader can enter a new order to “Sell to Open” further out expiration puts.
For example, the Sept. 15 expiration puts at the $47.50 strike price trade at a premium of 48 cents. That means that the short seller can make a yield of just over 1% in 3 weeks.
This is because if we divide $0.48 by $47.50, the yield-to-expiration is 1.01%.
Here is how that works. First, the trader sets up $4,750 in cash and/or margin per put shorted with their brokerage firm. So, for example, in order to short 3 puts, the trader would send $14,250 in cash and/or margin with the brokerage account.
Then, the trader can enter an order to “Sell to Open” 3 puts at the $47.50 strike price for expiration on Sept. 15. That immediately brings in $144.00 to the brokerage account (i.e., 3 x $48.00) from the 3 sold-short puts.
High Annualized Rate of Return
That is how the investor immediately makes 1% since $144 is 1.01% of the $14,250 invested in this trade. Keep in mind this money will be used to buy 300 shares of DVN stock if the price falls to $47.50 anytime during the next 3 weeks.
This is attractive to value investors as the annualized yield works out to 17.17%, since there are about 17 three-week periods in a year (i.e., 17 x 1.01% = 17.17%).
Note that this strike price is 5.75% below today's spot price. Some investors might want to take a more conservative way to increase their income. The $47.00 strike price puts have a 38-cent premium. That works out to an 80.8 basis yield or 13.75% on an annualized basis.
That is not too far below the 17% annualized rate at $47.50 but involves significantly less risk. The $47.00 strike price is 6.75% below the spot price, not the 5.75% width at the $47.50 strike price.
The bottom line is that by shorting these OTM put options investors can make extra income in addition to holding DVN stock long.
It also allows investors to potentially buy in at a much lower stock price. This happens if they hold the puts to expiration and they are exercised should the stock fall to the strike price level
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.
