Devon Energy (DVN) pays a 49-cent quarterly dividend, which includes a 29-cent variable portion (which is calculated as 50% of the adjusted free cash flow). As a result, DVN stock has an attractive 4.5% yield, based on an annualized $1.96 dividend.
However, depending on the results of cash flow during Q3, the dividend could be cut based on a lower variable portion of the dividend. However, even if that happens it does not seem that, given the high oil prices during Q3, the dividend cut may not be that high.
Where Things Stand With the Dividend
I discussed the stock's attractive dividend in my Sept. 12 Barchart article, “Devon Energy's 3.8% Dividend Yield Attracts Traders Along with Short Put Income Plays.”
Nevertheless, the stock has been having weak performance lately. The market perceives that oil prices may have peaked.
Although this may not directly affect the Q3 dividend, analysts are anticipating a dividend cut for Q4. That is most likely why DVN stock has been falling, along with the drop in oil prices.
But this presents a good value buying opportunity for investors. Moreover, it also makes shorting out-of-the-money (OTM) put options very attractive as an additional income play.
Shorting OTM Puts for Income
For example, the Oct. 27 expiration period shows that the $40 put option strike price has a premium of 33 cents. That means that an investor can sell short this put and receive an immediate yield of 0.825% over the next 3 weeks.
That works out to an annualized expected return (ER) of 14.0%, assuming an investor can repeat this trade 17 times during a year.
Moreover, keep in mind that this strike price is well over 8% below today's price. That means it provides good protection on the downside over the next 3 weeks.
Here is what that means exactly. An investor can secure $4,000 in cash and/or margin with their brokerage firm. That will allow them to enter an order to “Sell to Open” 1 put contract at $40.00 for expiration on Oct. 27.
The account will then immediately receive $33.00. That works out to 0.825% of the $4,000 invested. If done every 3 weeks for a year, that would bring in $561.00, or 14% of the $4,000 invested during that period.
So, for example, if the investor sold short 5 put contracts, they would have to secure $20,000 with the brokerage firm. But the income earned would be $165.00 over the 3-week period.
The investor's $20K would not be used or forced to buy shares in DVN unless it fell almost 8.5% to $40.00 per share.
Moreover, the investor's breakeven point would actually be $39.67 per share (i.e., $40-$0.33). That is 9.2% below today's price of $43.70 per share. So, this provides good downside protection to the investor.
The best way to do this is to also own DVN stock on a long basis. That way you can earn the high dividend yield along with the extra short put income.
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.
