High-grade preferred shares can offer an attractive alternative to bonds. As a rule of thumb, good quality preferred shares deliver about 80% of the yield available on good quality ten-year corporate bonds. That accounts for the favorable tax treatment of dividends for individuals and from corporation to corporation. However, in the current high risk environment, preferred shares are yielding about 5.5%. In essence a higher yield than is available on ten-year corporate bonds.

In my opinion, you could argue that good quality preferreds, particularly those issued by Canadian banks, provide a decent return versus the associated risk. I also think, given that Canadian banks have weathered this downturn better than most, that management will continue to pay the dividend on common shares. Which, if you accept that premise, means that there may be an opportunity to enhance that dividend yield through an in-the-money covered call write program.

For example, the Bank of Montreal (symbol BMO, listed TSX, recent price $51.29) pays an annual dividend of $2.80. The dividend yield is 5.45%. However, if you were to buy the shares and write say the January 2011 42 calls at $10.20 or better, you reduce the out-of,pocket cost for the shares to $41.09. A $2.80 annual dividend on a $41.09 stock price yields 6.81%.

The risk is that the options are exercised early. A common practice among traders is to exercise the option prior to a dividend payment in order to capture the dividend. That is a possibility with this strategy, which explains why the options are trading just slightly above their intrinsic value. Note with this option the intrinsic value is $9.29 ($42 strike price plus $9.29 intrinsic value = $51.29, which is the current price of BMO stock). However, that said, the current time value in this trade should allow you to capture at least two or three dividends before anyone considers exercising their position. If that happens, and the position is exercised before the fourth dividend payment (note: you are entitled to five dividends if the strategy plays out to January 2011), you still will earn a return in excess of 6% on the strategy. Which is still better than what you would get on most preferred shares.