The Striking Price

A Strategy That Pays Dividends

Steven M. Sears
Friday, December 19, 2014

Low volatility forced options investors to get more creative in 2014. Our conditional dividend strategy helped them make money.

In a year marked by low volatility, one must deal wisely with boredom. This column favored an approach I dubbed the conditional dividend strategy.

It involved selling puts on high-quality stocks with payouts. If the shares rose, as most did in 2014, the put sales simply generated added income. If the shares fell below the strike price at expiration, the put seller was obligated to buy the stock. There is nothing fancy about this options strategy, but it proved effective.

Consider CBOE Holdings (ticker: CBOE), which operates derivatives exchanges and developed the CBOE Volatility Index. The stock pays an annual dividend of 84 cents. It opened the year at $54.73 and recently traded at $64.47. The CBOE trade, selling a put, still makes sense. Selling the March 55 put generates a conditional dividend of 85 cents.

Focusing on increasing dividend income has never been a key concern of options traders. But it made sense in a year that didn’t lend itself to jazzier strategies, and at a time when bond yields are paltry.

Dividends historically provide 45% of equity returns. The column also recommended conditional-dividend trades involving BlackRock (BLK) and Microsoft (MSFT), among others. BlackRock shares have rallied 14% for the year to date, to a recent $347, and yield 2.2%. Microsoft is up 27%, to $45.43, and yields 2.6%.

THE OPTIONS MARKET witnessed an important evolution this year: Individual investors wised up, and began to trade volatility just like the pros. They sold puts and calls on individual stocks to take advantage of inflated options premiums. Increasingly, they used options to achieve the goal of buying low and selling high.

According to market strategists, mutual-fund managers also relied more on puts and calls to amplify their views of individual stocks, and profit from them.

The challenge for 2015 is how to handle long periods of little volatility, punctuated by sudden spikes in volatility that I have called volnados. They are often related to violent stock-market selling.

TD AMERITRADE LAUNCHED an educational campaign in July, called Keep Calm and Trade On, to teach its clients, largely individual investors, to be less reactive when volatility spikes. Fear-based decisions, as the firm reminded clients, often lead to bad outcomes. Many people were so afraid of losing more money after the financial crisis that they failed to notice and take advantage of the market’s turn in March 2009, which inaugurated one of the greatest bull markets in history.

The educational efforts appear to have worked, and the message is worth sharing. In October, when volatility spiked and stocks sank, TD Ameritrade clients bought stocks instead of selling, says Nicole Sherrod, managing director of trading. “They didn’t get out of the market,” she says.

During the selloff this month, she notes, clients created more position alerts and utilized the company’s technical-analysis tools, seemingly preparing to adjust trades based on market moves. That behavior is more in line with the way institutional investors handle volnados and potential market shifts.

Investors have learned from past crises how to make smarter decisions. We can only hope that our work has helped them, too.

Reprinted by permission of Barron's Online, © 2014 Dow Jones & Company, Inc. All Rights Reserved Worldwide.

The views expressed in the above papers and articles are solely those of the author of the article, and do not necessarily reflect the views of OIC; the information presented is not intended to constitute investment advice or recommendations to purchase or sell securities of any company; and the information presented is based upon particular events that may or may not recur in the future.

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