Chevron Corp (CVX) stock is attractive to value buyers with its dividend yield of over 4.0% and the dividend covered by free cash flow. Moreover, existing investors can make extra income by selling short out-of-the-money (OTM) put options in nearby expiry periods.
As of morning trading on Monday, May 20, CVX stock is trading for $162.16 per share. With the company's new annual dividend per share (DPS) of $6.52 (i.e., $1.63 quarterly x 4), the dividend yield is 4.02% (i.e., $6.52/$162.16).
Moreover, existing investors can make additional income by entering orders to “Sell to Open” put options at strike prices below today's price. I discussed this in my last Barchart article on April 22, “Chevron is Still Cheap with its Dividend Yield Over 4.0% and a 12x P/E Multiple.”
Strong Free Cash Flow
Since then, the oil and gas conglomerate reported strong free cash flow (FCF) Q1 results on April 26. This is still high enough to cover its large dividend payments.
For example, Chevron reported that its FCF was $2.7 billion in Q1, down from $4.2 billion in the year-earlier quarter period. Since Chevron now has 1.847 billion shares outstanding, that means its quarterly dividend will cost $3.01 billion each quarter (i.e., $1.63 qtrly DPS x 1.847b shs).
That cost is slightly higher than the $2.7 billion in FCF generated in Q1. However, Chevron likes to describe its FCF without including its working capital requirements, which can be volatile on a quarter-to-quarter and even a year-over-year basis. Using this measure, Chevron generated $3.883 billion in FCF ex W/C needs. That is higher than the $3.0 it spends on dividends.
Shorting OTM Puts for Income
After the Q1 results came out CVX stock fell by $3.73 since April 26 when it was at $165.89, a drop of 2.25%. That's nothing and is almost expected given the runup prior.
Investors still believe in the company's ability to pay such a strong dividend. Moreover, in my last Barchart article, I suggested shorting the $155.00 strike price put option expiring on May 10.
That play ended up expiring worthless since the stock price remained above the strike price and out of the money. This allowed the investor to not only keep the $1.19 income for an immediate yield of 0.768% (i.e., $1.19/$155.00) but there was also no obligation to buy shares at $155.00.
Note that this $1.19 in extra income for existing shareholders is almost as high as the quarterly $1.63 DPS. In other words, this kind of play works best for existing holders of CVX stock. Granted, they have to secure additional cash and/or margin with their brokerage firm to do this play. But I think it's worth the extra investment.
After all, even if the stock falls and the investor has to purchase shares at the strike price, they can secure another investment with an annual dividend yield of over 4.0%.
Rolling the Trade Over
Moreover, investors can do this OTM short-put play again for extra income. For example, look at the June 21 expiry period, 32 days from now. The $155 strike price, which is just over 4% below today's price, has a bid price of 72 cents. That provides an income yield of 0.465% (i.e., $0.72/$155.00).
That is a good yield for most investors with good downside protection over the next month. For example, the implied volatility (IV) ratio is only 16.82% which is very low compared to many other stocks.
In addition, the breakeven price is just $154.28 (i.e., $155-$0.72). That is 4.67% below today's price, providing even more protection. However, keep in mind that the investor must secure an additional $15,500 in cash and/or margin to enter an option trade to “Sell to Open” 1 put option contract at $155 for expiration on June 21. The account will then receive $72.00.
Moreover, for investors willing to take on more risk, they can sell short the $157.50 strike price. The premium received will be $1.18. That means by investing $15,750 (only 1.6% more than the $15,500 at the $155 strike price level), the investor can immediately make $118 (+63.8% more than the $72 at the $155 strike price).
However, there is a greater risk that the stock could fall to $157.50 on or before June 21, forcing the short seller to buy shares at that price. That may not necessarily be so bad. For example, when buying shares at this strike price, the annual dividend yield is well over 4.0% (i.e., $6.52/$157.50 = 4.14%).
The bottom line is that CVX stock looks cheap here based on its 4.0% dividend yield. Shorting OTM puts is a good way to make extra income, especially for existing investors.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
