Telecom, utilities and energy stocks have been hit hard since the U.S. presidential election -- and it has presented buying opportunities for some investors who are seeking income.
Since reaching highs of $86 in July, Duke Energy (DUK) , a Charlotte, N.C.-based utilities company, has faced headwinds. Investors can use a LEAP buy/write strategy to find a "comfort level and collect some dividend income while waiting," said Ron McCoy, a portfolio manager on Covestor, the online investing company, and founder of Freedom Capital Advisors in Winter Garden, Fla.
In the aftermath of the election, interest rates have been increasing, with mortgage rates rising and the yields of the 10-year Treasury surging to 2.3%, an increase of 50 basis points from 1.80%. While bank stocks like JPMorgan Chase (JPM) and Bank of America (BAC) have rallied, telecoms like AT&T (T) and Verizon (VZ) and utilities like Duke Energy have been "caught in the draft," McCoy said.
One of the hardest things in buying stocks at a bargain is trying to find a bottom, McCoy noted. Using a LEAP buy/write strategy, investors with a bearish outlook on a stock can find a comfort level and collect dividend income while waiting. LEAPS are options with an expiration date out one year or more -- providing some downside protection and upside benefit while allowing an investor to take a long-term position in a stock.
Duke Energy is trading at $74 -- down from a 52-week high of $87.75. The company's earnings are estimated to be $4.67 this year and flat next year. At current levels, Duke yields 4.6%, but by doing a buy/write using LEAPS, investors can get their cost down almost 15% from current levels.
Investors would buy the stock and sell a January 2018 $65 call against the position for a premium of $1.75. This reduces the cost to $63.25 and has a maximum profit potential of 8% over 14 months.
"When doing deep in-the-money calls, it is possible to get called away early," McCoy said. "However, if it is called away before the next dividend of $0.855 in February, investors would still make $1.75 on a $63.25 investment -- or 2.7% in three months."
If investors collect the dividend in February, the return would be $2.605 -- or 4.1% -- at that point. Investors who want to be more aggressive could sell the $70 or $75 strikes on Duke against their long Duke shares. (One call is equal to 100 shares.)
"Searching for yield and safety is not easy in today's market, but owning Duke Energy down in the low $60s via a January 2018 $65 buy/write is not a bad place to be," McCoy said.
Selling a call will offset part of the cost of buying the stock, and at the same time and it is a sensible strategy if the stock price has a bearish outlook and the future stock price will not go over the breakeven level, which is the strike price and the option premium, said K.C. Ma, a CFA and director of the Roland George investments program at Stetson University in Deland, Fla.
"It becomes even more attractive for the dividend-paying stock since its price has a natural tendency to go down for the amount of dividend paid at the ex-dividend day, even with a neutral outlook of the stock," he said.
Duke has dropped from $80 to $74, which is a 7.5% loss in just a week. So utility investors who seek high dividend yields are getting a 7.5% discount to purchase Duke already.
Investors can enter the long stock position to receive a 10% discount from the current level by buying the stock at $74 and selling a January 2018 $70 call LEAP for $7.20 premium, Ma said. This reduces the total cost down to $66.80, compared with buying the stock outright at $74.
"Either way, investors can sit to collect the same dividend of $0.855 in February," he said.
Options investors should be cautioned that sellers of deep in-the-money calls could get called away early, Ma said. If the stock price rebounds over the breakeven price level, such as $77.20, investors of long stocks and short LEAPS will be worse off than the ones without shorting the LEAPS.
"The right question to ask is, "what are the odds that the Duke stock prices will go over $77.20 from the current $74 any time before January 2018?" he said. "Considering the uncertainty of the number of times the Federal Reserve will raise the rates in 2017 and how much upside for the 10-year rates to go up from here, it is anyone's call."
--Written by Ellen Chang