Seeking Income

Individuals invest for many reasons. Investing being the key word in that sentence. Investing is about making medium to long term commitments with a specific goal in mind. And it is more than simply saying I want to make money!

In fact setting an objective can be the hardest decision individuals make. I should know I have spent twenty years as a money manager trying to get people to think about goals, risk management and time lines. And then to look at securities in terms of what they bring to the overall portfolio in terms of risk and potential return.

Generally speaking, capital appreciation is the most commonly cited objective. Yet, when you examine where you are in your life cycle, capital appreciation may not be the appropriate choice. Retirees for example, should be seeking income that they can draw from their portfolio.

To that point, options can play a role. Covered call writing that is often talked about in this space is an important income enhancement strategy that produces tax-advantaged income. So do dividends which should be a focus for income producing investors. The trick is to stay focused on the income being generated from the dividends rather than noise induced swings in the value of the shares.

With that in mind I wanted to look at options enhancements using stocks that pay above average dividends. The first is BCE Inc. the Canadian telecommunications giant. BCE Inc. (Symbol BCE, Friday’s close $53.76) is a mature company which is what makes it interesting for this strategy. Investors buy it for the dividend (current annual divided is $2.60 yielding 4.83%) not so much for the long term capital appreciation.

BCE also has a liquid options market which allows us to sell covered calls to further enhance the cash flow from this security. In this case, you could buy the shares at $53.76 and write the January 54 calls at $1.45. The six month return if the shares are called away in January is 5.56% including the two quarterly dividends that will be paid out during the holding period. Return if unchanged is 5.12%.

Another company with an excellent dividend is Algonquin Power & Utilities Corp. (AQN, Friday’s close $9.74). AQN is a renewable energy and regulated utility company providing regulated water, electricity and natural gas utility services.

Year-to-date, the share price has bounced between $8.50 and $10.50. The stock had a major setback in March when the share price fell from $10.20 to $8.50 in a matter of days. The result of a notice from CRA that the government intended to reassess the company’s 2009 through 2013 income tax filings in relation to a unit exchange transaction that occurred on October 27, 2009, whereby unit holders of Algonquin Power Income Fund exchanged their trust units on a one-for-one basis for common shares of APUC (the “Unit Exchange”).

Not to get into the nuts and bolts of government oversight suffice it to say smaller companies can be subject to shocks that are hard to forecast. Still, the shares have rebounded nicely from that point and the 5.177% dividend yield looks reasonably safe. AQN has options and with the choppy action earlier in the year, the premiums provide a reasonable buffer.

To that end, you could buy AQN at $9.74 and write the January 10 calls at 45 cents. Six month return if exercised is 9.14%, return if unchanged 6.47%. Both returns include dividends.