By Greg Patrick, Trades Of The Day,Trades Of The Day, 2024-09-18
Right now we have an opportunity to make outsized income from Dividend Aristocrat Medtronic (MDT), which looks 13% undervalued at recent prices.
In short, shares of MDT yield 3.2%, but by selling a select covered call option we can create higher income instantly, generating an annualized yield of 15.2%-23.6%, and lower our cost-basis in the process (thus, reducing risk).
Here's how…
As we go to press, MDT is selling for $88.13 per share and the December 20 $90 calls are going for about $2.72 per share.
Our income trade would involve buying 100 shares of MDT and simultaneously selling one of those calls.
By selling this call option, we would be giving the buyer of the option the right, but not the obligation, to purchase our 100 shares at $90 per share (the “strike” price) anytime before December 20 (the contract “expiration” date).
In exchange for that opportunity, the buyer of the option would be paying us $2.72 per share (the “premium”).
There are two likely ways this trade would work out, and they both offer significantly higher income than what we'd collect if we relied on the stock's dividends alone. And since we're collecting immediate income from selling the call, we're lowering our cost-basis as well ( which helps reduce our risk).
Let's take a closer look at each scenario…
Scenario #1: MDT stays under $90 by December 20
If MDT stays under $90 by December 20, our option contract would expire and we'd get to keep our 100 shares.
In the process, we'd receive $272 in premium ($2.72 x 100 shares).
That income would be collected instantly, when the trade opens.
Excluding any commissions, if “Scenario 1” plays out, we'd receive a 3.1% return in the form of income for selling the covered call ($2.72 / $88.13). Since we'd be in the trade for 93 days, this scenario would work out to a 12.1% annualized yield.
Plus, since Medtronic goes ex-dividend on September 27, we'd also be in line to collect its next quarterly dividend of $0.70 per share. That extra $70 ($0.70 x 100 shares) would lift our annualized yield to 15.2%.
Scenario #2: MDT climbs over $90 by December 20
If MDT climbs over $90 by December 20, our 100 shares would get sold (“called away”) at $90 per share.
In “Scenario 2” — like “Scenario 1” — we'd collect an instant $272 in premium ($2.72 x 100 shares) when the trade opens… we'd be on record to collect $70 in dividends ($0.70 x 100)… AND we'd also generate $187 in capital gains when the trade closes because we'd be buying 100 shares at $88.13 and selling them at $90.00.
In this scenario, excluding any commissions, we'd be looking at a $529 profit.
From a percentage standpoint, this scenario would deliver an instant 3.1% in income for selling the covered call ($2.72 / $88.13)… 0.8% from the dividend ($0.70 / $88.13)… and a 2.1% return from capital gains ($1.87 / $88.13).
At the end of the day, we'd be looking at a 23.6% annualized yield from MDT.
Here's how we'd make the trade…
We'd place a “Buy-Write” options order with a Net Debit price of as close to $85.41 ($88.13 – $2.72) as we can get — the lower the better. Options contracts work in 100-share blocks, so we'd have to buy at least 100 shares of Medtronic (MDT) for this trade. For every 100 shares we'd buy, we'd “Sell to Open” one options contract using a limit order. Accounting for the $272 in premium we'd collect, that would require a minimum investment of $8,541.
Greg Patrick
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