There are certain blue chip stocks that are basic staples in many investors’ portfolios. These are often safe dividend payers that can be trusted to earn income (and pay dividends) throughout the market’s ups and downs. However, from time-to-time, these stocks can get a bit frothy, and the near-term upside can seem limited. This is our view of Procter & Gamble (PG) right now, and we are sharing an options trade that generates upfront income and adds discipline to your sell decisions. We current own PG, and we believe this is an attractive trade to place today (and potentially over the next few trading days) as long as the price doesn’t move too dramatically before then.
The blue line in the chart above is the total return of Procter & Gamble (PG).
The Trade: Procter & Gamble
Sell (Covered) Call Options on Procter & Gamble (PG) with a strike price of $125 (6.1% out of the money), and an expiration date of July 17, 2020, and for a premium of $0.96 (this comes out to over 6.6% of extra income on an annualized basis, ($0.96/$118.23 x (365/43 days to annualize). This trade generates attractive income for us now, and it also gives us the possibility of selling our shares at a 6.6% premium to the current price (if they rise and get called away from us prior to expiration). If the shares don’t get called away from us, we simply keep the upfront premium income we generated, and we keep owning this dividend paying “forever stock.”
Note: If you want higher upfront income, and a higher chance of having the shares called from you, consider selling the $120 strike price instead.
Your Opportunity:
We believe this is an attractive trade to place today and potentially over the next few trading days as long as the price of PG 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 6% to 8%, or greater.
Our Thesis:
Our thesis is basically that we like P&G because it is a tried and true, trusted, dividend payer, but its price has gotten a little bit frothy. Specifically, we like P&G because it is a leading household and personal care manufacturing company with significant market share in baby care, razors, feminine products and fabric care, and we believe these are industries that will largely weather most economic storms. And we also like that P&G streamlined its product portfolio in 2014-2016 (they got rid of about 100 of their lower margin brands and kept the stronger ones only—they now have approximately 65 separate brands remaining).
However, we believe the shares are getting expensive. One very simple straight forward way to value P&G is its dividend yield (see the Dog of the Dow Strategy). When the yield is high, the shares are cheap, and when the yield is low the shares are expensive. This may sound like a ridiculous oversimplification, but considering the high stability and predictability of the business, the dividend yield is simply a signal from management about how they believe the stock is valued (i.e. management sets the dividend at a reasonable level for the business, but they cannot control the shares price). As you can see in the chart below, P&G shares have performed well, and the dividend yield has mathematically fallen relatively low (even though P&G has not reduced the dividend, they just keep raising it).
Further still, P&G has recently experienced added strength as “stay at home” orders have given an added bump to sales that we believe is not entirely permanent.
Essentially, we have earned solid gains and dividends by owning P&G in recent years and we wouldn’t mind if the shares were “called” off our hands in the next 45 days at an even higher price than they already trade at. And if the shares don’t get called away from us, we’re happy to keep the upfront premium income we generated for selling the calls (we keep this income no matter what), and we also get to keep handing on to P&G for its safety and its dividend.
Important Trade Considerations:
Please also keep in mind, options contracts trade in lots of 100, so to secure this trade with shares (in case the shares get called from) you’ll need to keep 100 shares of P&G in your account.
Two additional considerations when selling call options are dividends and earnings announcements because they can both impact the price and thereby impact your trade. In this particular case, they are both largely non-issues because P&G isn’t expected to announce earnings again until July (after this contract expires), and it won’r go ex-dividend again until July (again, after this contract expires). Had either of these events been scheduled for before this options contract expires, we’d need to be comfortable with the added risks (i.e. we’d need to receive more upfront premium income on the trade).
Conclusion:
P&G is a healthy, blue chip, dividend-paying powerhouse, but the shares are a bit on the expensive side. In our view, these are attractive market conditions to generate a little extra income with this P&G trade (it’s a “covered call” strategy, also sometimes referred to as a “buy write” strategy). P&G is a good target for this trade, but you may have another names in mind where this income-generating options trade strategy may work for you. Compared to other options trading strategies with much higher risk and volatility—the premium income on this trade may seem like small peanuts. But this is a low risk options trade that can add to your stockpile of cash (for spending or reinvesting), and it can also help you add discipline to your buying and selling methodology. If the shares go another 6.1% higher from here, why not sell, and you get to keep the added premium income from this trade no matter what.