An Electrifying Yield on a Utility Stock

Utility stocks are often loved by yield investors. They provide steady dividends, are regulated businesses, and are less cyclical. Generally they can be called “boring,” but for the investors who own utility stocks that is what they love about them. We’ve seen this sector do well over the last few decades as interest rates have come down and investors seek yield.

Fortis (FTS) has raised its dividend for 43 consecutive years. The company currently derives 96% of their earnings from regulated businesses which makes their earnings very stable and helps to secure the dividend. Looking at performance over the last decade, the stock has an annualized return of 9.64%. At present, the year-to-date total return is 11.44%. Rather than buying the stock to collect the ever-increasing dividend, an investor can consider selling a Put as a different way to generate income.

Currently, Fortis shares are trading at $40.25 (as of October 11, 2016). An investor can collect $1.53 in premiums for the January $40 Put. This premium represents 3.83% of the underlying strike price (96% of the annual dividend) in just 101 days. If we annualize that number (calculation below), we come up with 14.55%, which is significantly more than the 10 year annualized return. If at expiry the stock is below $40, the net purchase price on delivery will be $38.47. This represents a 14% discount to the 52 week high and gives a yield on cost of 4.15%. If delivery is taken on the stock, an investor can either put the stock in the long-term hold portion of their portfolio and collect that dividend, or look to sell some Calls. However, keep in mind that the Call market on utility stocks is often dampened by the dividends.

I think this is an opportunistic trade, taking advantage of the recent uptick in interest rates that pushed down utilities. When trying to decide what options to sell, part of the process is taking a look at how they are priced. At the risk of getting too technical, these options are priced with an implied volatility of 17.91%, compared to the 30 day realized volatility of 13.93%. Ultimately, sellers are getting paid more for the option than recent history would suggest they should. The reason in this case is that Fortis is reporting earnings on November 4, 2016. Earnings announcements and other events often create enough uncertainty to increase the price of the options. If it is a company that is suitable to your investment objectives, and that you are comfortable owning at that level, that is when you should step in and take in the premium.

The information contained herein is for general information purposes only and is not intended to provide financial, legal, accounting or tax advice and should not be relied upon in that regard. Many factors unknown to Christopher Thom may affect the applicability of any matter discussed herein to your particular circumstances. You should consult directly with your financial advisor before acting on any matter discussed herein. Individual situations may vary.