Sectors To Watch: Power Up Your Cash Flow With Utilities
Investing in electric utilities, multi-utilities, independent power producers, energy traders, and gas utilities isn’t as flashy as investing in a hot biotech stock or tech stock IPO. But utilities stocks are a staple for investors interested in income generation more so than growth.
And for good reason…
High quality dividend paying stocks like those found in the utilities sector are one of the few places investors can generate a decent yield on their investment these days. And with the Fed committed to keeping interest rates low until the unemployment level drops, interest rates should remain low through the end of this year and perhaps well into 2014.
That means utilities and other dividend paying stocks are income investors’ best bet to make more than the 2% yield you can get on a diversified fixed income ETF today.
Obviously, a 2% yield doesn’t cut it for many income investors. As a result, we’ve seen some investors pulling out of fixed income ETFs and putting that money to work in ETFs with bigger dividend yields.
Right now the Utilities Select Sector SPDR Fund (XLU) pays an annual dividend of $1.45. At a recent price of $37.18, that’s a dividend yield of 3.9%… or nearly twice as much as the diversified bond fund.
What’s more, XLU has a greater potential for growth. XLU is up an impressive 6.5% year to date to $37.18. But unlike the S&P 500 that is back near the all-time highs it set back in 2007, XLU still need to gain an additional 20% to reach its all-time high of $44.66.
But here’s the thing…
We’re not buying XLU for the upside. I don’t see XLU going up 20% to test the all-time high in the near future. I do however believe XLU will continue to advance along the well established uptrend. But that doesn’t give XLU much upside in the next 6 to 12 months.
This scenario creates an opportunity for income investors to use a covered call strategy to increase the amount of income they can collect on their XLU holdings.
Right now you can buy 1,000 shares of XLU for $37,180. And you can sell the XLU June 2013 $38.00 call for 36 cents. Keep in mind, since you can sell one option contract for every 100 shares of stock you own, you can sell 10 contracts and collect $360.
And don’t forget you’ll also collect two quarterly dividends of approximately 40 cents per share before these options expire. That alone will generate $800 in dividends in the next four months.
If XLU stays below $38.00 through June 22nd, the options will expire worthless. You’ll keep the 1,000 shares of XLU, the $360 in option premium, and the $800 in dividends.
At this point, you can sell your 1,000 shares of XLU or you can sell another covered call against your XLU holdings and continue to collect the dividend and option premium.
If XLU continues to rally, your stock will likely be called away if XLU gets above $38 prior to June 22nd. In this case, you’ll collect $820 on the sale of the stock, you still get to keep the $360 in option premium, and whatever dividends you collect before the stock is called away.
As you can see, using a covered call strategy like this is a simple way to generate income far and away better than you can get by simply investing in bonds or even in dividend stocks alone.
Good Investing,
Corey Williams
Category: Options Trading
