Devon Energy (DVN) stock has been treading water since its Q1 results were released on May 8. This is good for investors who have been short its out-of-the-money puts, whose premiums are sinking. DVN stock closed at $49.17 on May 9, and as of May 26, it was at $48.07.
This is good news for investors who short the out-of-the-money (OTM) puts. That is because as long as the stock does not crater, DVN put option premiums will wither. That allows the short-put investor to make money as the options fall in price.
Dividend Cut Still Hurting Stock
For example, we wrote about the company's earnings and dividend cut on May 9 in our article, “Devon Energy Cut Its Dividend Giving DVN Stock An Attractive 5.77% Yield.” We pointed out that although Devon Energy had higher oil production during the quarter, its free cash flow (FCF) was lower.
In fact, FCF fell by $435 million or 40% in Q1 from $1.1 billion to $665 million. This meant that the company had to cut the variable portion of its fixed and variable dividends. This is because the company pays out 50% of its net FCF in the variable portion of the dividend.
Its fixed dividend is 20 cents, but the variable portion was reduced from 79 cents to 52 cents. So the total dividend is now $0.72, or $2.88 per share annually. So at $48.07 today, the stock yields 5.99%.
This also implies that if the oil market stays weak during Q2, Devon may have to cut its variable dividend further. That is what is weighing on the stock.
Using Short Puts to Create Extra Income
Investors who are long DVN stock can create extra income by shorting OTM puts, as I wrote in my May 9 article. I suggested that shorting the $44.00 strike price puts for the June 9, 2023, expiration period would be worth doing.
That was because the put premium received was 50 cents per contract. This means that the investor who shorted the $44.00 strike price put by securing $4,400 with their brokerage firm will have received $50. That works out to an immediate 1.136% yield (i.e., $50/$4,400).
Today, those same put premiums are lower, trading for just 34 cents with just 13 days left until expiration. That means that if DVN stock stays at this level over the next two weeks, these put option premiums will expire worthless. That is exactly what the short-put premium investor wants to see.
Moreover, some investors may want to go further out in expiration to short DVN puts to create more income. For example, the June 23 expiration $42.00 strike price put options trade for 49 cents. That produces an immediate income yield of 1.167% to the short-put investor.
This means that the investor who secures $4,200 in cash and or margin with the brokerage firm can then enter an order to sell short the $42.00 strike price put. They do this by making an order to “Sell to Open” the strike price at $0.49. Immediately the account will receive $49.00.
Now, so long as DVN stock does not fall to $42.00, which is 12.63% below today's price, the investor will not be obligated to purchase DVN stock at $42.00 with the $4200 already secured with the brokerage firm. Even it does fall to $42.00 on or before June 6, the investor's breakeven price is $41.51, before they have an unrealized loss in holding 100 shares of DVN stock.
And keep in mind as well that at that price the investor makes a 6.938% dividend yield (i.e., $2.88/$41.51). So this is a good way for a long-term investor in DVN stock to make extra income and lower their buy-in cost.
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.
