Devon Energy (NYSE:DVN) currently offers an attractive dividend yield of 4.5%, making it an enticing option for income-seeking investors. The company pays a quarterly dividend of 49 cents per share, which includes a variable portion of 29 cents. This variable component is calculated as 50% of the adjusted free cash flow.
Based on an annualized dividend of $1.96, DVN’s dividend yield stands at 4.5%. However, it’s important to note that the actual dividend payout may fluctuate based on the company’s cash flow results for the third quarter. In the event of lower free cash flow, the variable portion of the dividend could be reduced. Nevertheless, given the favorable oil prices experienced during Q3, any potential dividend cut may not be substantial.
The Current Status of the Dividend
Despite the dividend’s appeal, DVN’s stock has faced recent weakness in performance, likely due to market concerns that oil prices may have reached their peak.
While this perceived peak in oil prices may not directly impact the Q3 dividend, analysts are anticipating a potential dividend reduction in Q4. This expectation has contributed to DVN’s declining stock price, which has been coupled with the broader decrease in oil prices.
A Value Opportunity for Investors
Nevertheless, this situation presents a valuable buying opportunity for investors looking to enter the market at a lower price point. Additionally, it also makes shorting out-of-the-money (OTM) put options an attractive income-generating strategy.
Generating Income by Shorting OTM Puts
For instance, consider the October 27th expiration period, where the $40 put option strike price carries a premium of 33 cents. Investors can sell short this put option and receive an immediate yield of 0.825% over the next three weeks.
This annualizes to an expected return (ER) of 14.0%, assuming an investor can replicate this trade 17 times in a year. Importantly, this strike price provides significant downside protection, being over 8% below the current stock price.
To illustrate, an investor can allocate $4,000 in cash or margin with their brokerage firm to sell to open one put contract at $40.00 for expiration on October 27th. This would result in an immediate receipt of $33.00, equivalent to 0.825% of the $4,000 invested. If repeated every three weeks for a year, this strategy could generate $561.00, representing 14% of the $4,000 invested over that period.
For instance, if an investor decided to short five put contracts, they would need to allocate $20,000 to the brokerage firm. However, the income earned would amount to $165.00 over the three-week period. Importantly, the investor’s $20,000 would not be utilized or required to purchase DVN shares unless the stock experienced a significant drop of nearly 8.5% to reach $40.00 per share.
Moreover, the investor’s breakeven point is $39.67 per share ($40 – $0.33), which is 9.2% below the current price of $43.70 per share. This approach provides robust downside protection for investors.
Optimizing with a Long DVN Stock Position
A prudent way to execute this strategy is to also hold a long position in DVN stock. By doing so, investors can benefit from the high dividend yield while concurrently generating additional income through short-put options.
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Author Faith Yakubu