Despite last week’s overreaction to the Fed, the market will likely continue sideways for a while for two reasons. One, the market indexes had to take a breather after a massive 90% move higher from the pandemic lows. Two, investors look ahead and can’t decide what will drive the market six months from now after the economy slows and comparisons get tough.
In a sideways market, income is at a premium. Income is the only game in town when stock prices aren’t rising. Dividends roll in regardless of near-term market gyrations. Covered calls greatly enhance that income.
In times like this, a portfolio geared towards high income can provide strong returns while the overall market languishes. In this issue, I highlight two new covered call opportunities that will enable you to ring the register while the market wallows.
Cabot Income Advisor 621
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Attack of the Bored Traders
The sideways market finally got some action. It went the wrong way. But it showed signs of life nonetheless.
Last week, the Dow Jones Industrial Average posted its worst week since last August, down more than 3.4%. The main culprit was the Fed. At last Wednesday’s meeting, the central bank announced its intention to start hiking the federal funds rate – in two years. That is sooner than the market had anticipated. And investors freaked.
Two types of stocks got hit the worst: companies that benefit from a steeper yield curve and anything commodity related. Higher anticipated short-term rates combined with the recent pullback in the 10-year Treasury rate flattened the yield curve. Banks and mortgage REITs sold off. The Fed’s more hawkish than expected stance on fighting inflation caused commodity prices to tumble in anticipation of less inflation going forward.
I think it was an overreaction.
Will the yield curve continue to flatten? The 10-year rate has been consolidating since April after a huge surge at the beginning of the year. The only thing that has changed since April is that the reason for the surge in rates has become a reality. There is a good chance longer rates will trend higher the rest of the year. And the short-term rates aren’t going anywhere for another two years.
Then there’s inflation. We’re seeing the highest inflation in decades amidst supply shortages in the unprecedented economic shutdown last year and start-up this year. Inflation was always likely temporary until supply issues get resolved. But if there is longer-term systemic inflation that will last because of increased money supply from trillions in stimulus and a booming economy, a couple of measly 0.25% rate hikes two years from now isn’t going to stop it.
Wall Street traders are bored to tears. The red-hot stock market turned into a great big dud over the last couple months. They’re looking for any excuse to get some action. They make a big deal out of anything because they don’t have anything better to do. It’s just a lot of short-term nonsense.
The real reason for the sideways market is twofold. One, the market indexes had to take a breather after a massive 90% move higher from the pandemic lows. Two, investors look ahead and can’t decide what will drive the market six months from now after the economy slows and comparisons get tough.
The best place to be is in stocks of companies that will continue to thrive in the post-pandemic environment. Most of our portfolio positions were selected not to ride a wave of hysteria, but because they represent good value and bright prospects beyond the current headlines.
What to Do Now
The market may go sideways for a while longer. So, income is at a premium. In the absence of rising stock prices, income is the only game in town. Dividends roll in regardless of near-term market gyrations. Covered calls greatly enhance that income.
Three existing calls in the portfolio expired on Friday. The calls for AGNC Investment Corp. (AGNC) and U.S. Bancorp (USB) expired out-of-the-money and we will retain those stocks to write more calls and collect more dividends going forward. Calls for KKR & Co. (KKR) expired in-the-money and those shares were called away. But we managed a better than 20% return between the call, the dividend and capital appreciation in less than three months.
In last week’s update, we targeted a call on data center REIT Digital Realty (DLR) but the stock sold down last week and you have not been able to get the targeted 8 per-call price. But we will leave that trade pending for now, as the stock could recover in the next week or two.
Most of the current portfolio positions had been rising to new recent highs in the flat market as investors seek value and income. But several positions took a hit last week. AGNC and USB were hit by the flattening yield curve trade. Also, Enterprise Product Partners (EPD) and ONEOK (OKE) traded down in sympathy with the overall energy sector, despite the fact that they are not levered to commodity prices.
As I mentioned above, I believe last week’s action was a temporary overreaction. And I expect the stocks to recover in the days and weeks ahead. The overall portfolio is still well positioned and provides great dividend income. In fact, most of the positions are still in the BUY range and you can purchase them at current prices if you don’t own them already.
In times like this, a portfolio geared towards high income can provide a strong return while the overall market languishes. In this issue, I highlight two new covered call opportunities.
Monthly Recap
May 26
Buy ONEOK stock (OKE) - $52.51
June 15
Sell DLR July 16 $155 calls at $8.00 or better
June 18
AGNC June 18 $17 call at $0.50 - Expired
KKR June 18 $55 calls at $3.00 - Expired
USB June 18 $57.50 calls at $2.80 - Expired
KKR & Co. stock (KKR) - Called at $55
June 23
Sell AGNC August 20 $17 calls at $0.50 or better
Sell OKE August 20 $57.50 calls at $1.65 or better
Featured Actions
Alert: Sell AGNC August 20 $17 calls at $0.50 or better
Expiration date: August 20
Strike price: $17
Call price: $0.50
AGNC Investment Corp (AGNC)
It worked once. The previously written calls expired last Friday. Let’s get right back on the horse and do it again. Of course, there is a strong chance that shares could be called early if the stock appreciates from here, as investors may want to be eligible for the monthly dividends. Realize that going in. But the call premium represents a little more than four months of dividends up front. In this uncertain summer market, let’s lock in the high income.
The first scenario considers the 17 per share current purchase price and not the original 15.52 purchase price of the shares in the portfolio. The scenarios also do not include the 0.50 premium received on the previously written calls or the five months of dividends received since the position was originally established.
- 1. The stock closes above the $17 strike price at expiration
- Call premium: $0.50
- Dividend: $0.12 (ex dividend June 29th)
- Dividend: $0.12 (ex dividend July 30th)
- Total: $0.74 (total return will be 4.3% in two months)
- 2. The stock price closes below our $17 strike price.
- Call premium: $0.50
- Dividend: $0.12
- Dividend: $0.12
- Total: $0.74 (total income return of 4.3% in two months)
- 3. The stock price declines.
- The decline will be offset by the $0.74 in income.
Alert: Sell OKE August 20 $57.50 calls at $1.65 or better
Expiration date: August 20
Strike price: $57.50
Call price: $1.65
ONEOKE Inc. (OKE)
I somewhat hesitate to sell these calls because I’m very bullish on the prospects for this stock through the rest of the year. But two things are making me pull the trigger. One, I’m not very confident in the direction of the market over the summer months. Two, the portfolio split it down the middle by continuing to hold EPD but not writing a call on it. It’s a good hedge. If midstream companies rally, we still have EPD. If they don’t, we’ll get a high income from OKE.
It’s also worth noting that OKE is a more volatile stock and commands a higher call premium. We are also writing the calls when the stock is $2.50 per share out-of-the-money.
Here are the three basic scenarios.
- 1. The stock closes above the $57.50 strike price at expiration
- Call premium: $1.65
- Dividend: $0.935 (payable Aug 14)
- Appreciation: $4.99 ($57.50 strike price minus $52.51 purchase price)
- Total: $7.58 (total return will be 14.4% in 3 months)
- 2. The stock price closes below our $57.50 strike price.
- Call premium: $1.65
- Dividend: $0.935
- Total: $2.59 (total income return of 4.9% in 3 months)
- 3. The stock price declines.
- The decline will be offset by the $2.59 in income. Of course, there is some leeway to work with since the purchase price was $4.99 per share below the strike price.
Portfolio Updates
| CIA STOCK PORTFOLIO | |||||||
| Open Recommendations | Ticker Symbol | Entry Date | Entry Price | Price on 6/22/21 | Buy at or Under Price | Yield | Total Return |
| AGNC Investment Corp. | AGNC | 01/13/21 | 15.52 | 17.07 | 17.00 | 8.44% | 13.93% |
| Brookfield Infrastructure | BIP | 01/13/21 | 50.63 | 54.32 | 53.00 | 3.77% | 9.36% |
| Digital Realty Trust | DLR | 1/27/21 | 149.17 | 155.68 | 155.00 | 3.01% | 6.02% |
| NextEra Energy, inc. | NEE | 2/24/21 | 73.76 | 74.33 | 80.00 | 2.07% | 1.84% |
| Enterprise Product Partners | EPD | 3/17/21 | 23.21 | 24.05 | 25.00 | 7.48% | 5.98% |
| U.S. Bancorp | USB | 3/24/21 | 53.47 | 55.98 | 55.00 | 3.00% | 5.48% |
| KKR & Co. | KKR | 3/24/21 | 47.98 | 57.90 | 50.00 | 1.00% | 20.99% |
| Qualcomm Inc. | QCOM | 5/5/21 | 134.65 | 133.96 | 140.00 | 2.05% | -0.01% |
| ONEOK, Inc. | OKE | 5/26/21 | 52.51 | 55.59 | 60.00 | 6.73% | 5.87% |
| EXISTING CALL TRADES | |||||||
| Open Recommendations | Ticker Symbol | Initial Action | Entry Date | Entry Price | Price on 6/22/21 | Sell To Price or Better | Total Return |
| AGNC June 18 $17 call | AGNC210618C0017000 | Sell | 4/13/21 | 0.50 | 3.20% | ||
| KKR June 18 $55 call | KKR210618C00055000 | Sell | 4/28/21 | 3.00 | 6.25% | ||
| USB June 18 $57.50 call | USB210618C00057500 | Sell | 4/28/21 | 2.80 | 5.24% | ||
| DLR Jul 16 $155 call | DLR210716C00155000 | Sell pending | 3.10 | 8.00 | 5.36% | ||
| AGNC Aug 20 $17 call | AGNC210820C00017000 | Sell pending | 0.52 | 0.50 | 3.00% | ||
| OKE Aug 20 $57.50 call | OKE210820C00057500 | Sell pending | 1.65 | 1.65 | 3.14% | ||
| SOLD STOCKS | |||||||
| Security | Ticker Symbol | Action | Entry Date | Entry Price | Sale Date | Sale Price | Total Return |
| Innovative Industrial Props. | IIPR | Called | 6/2/20 | 87.82 | 9/18/20 | 100.00 | 15.08% |
| Qualcomm | QCOM | Called | 6/24/20 | 89.14 | 9/18/20 | 95.00 | 7.30% |
| U.S. Bancorp | USB | Called | 7/22/20 | 36.26 | 9/18/20 | 38.00 | 3.42% |
| Brookfield Infras. Ptnrs. | BIP | Called | 6/24/20 | 41.92 | 10/16/20 | 45.00 | 8.49% |
| Starbucks Corp. | SBUX | Called | 8/26/20 | 82.41 | 10/16/20 | 88.00 | 6.18% |
| Visa Corporation | V | Called | 9/22/20 | 200.56 | 11/20/20 | 200.00 | 0.00% |
| AbbVie Inc. | ABBV | Called | 6/2/20 | 91.04 | 12/31/20 | 100.00 | 12.43% |
| Enterprise Prod. Prtnrs. | EPD | Called | 6/24/20 | 18.14 | 1/15/21 | 20.00 | 15.16% |
| Altria Group | MO | Called | 6/2/20 | 39.66 | 1/15/21 | 40.00 | 7.31% |
| U.S. Bancorp | USB | Called | 11/25/20 | 44.68 | 1/15/21 | 45.00 | 1.66% |
| B&G Foods Inc, | BGS | Called | 10/28/20 | 26.79 | 2/19/21 | 28.00 | 4.42% |
| Valero Energy Inc. | VLO | Called | 8/26/20 | 53.70 | 3/26/21 | 60.00 | 11.73% |
| Chevron Corp. | CVX | Called | 12/23/20 | 85.69 | 4/1/21 | 96.00 | 12.95% |
| KKR & Co. | KKR | Called | 3/24/21 | 47.98 | 6/18/21 | 55.00 | 14.92% |
| EXPIRED OPTIONS | |||||||
| Security | In/out money | Sell Date | Sell Price | Exp. Date | $ Return | Total % Return | |
| IIPR Jul 17 $95 call | out-of money | 6/3/20 | 3.00 | 7/17/20 | 3.00 | 3.40% | |
| MO Jul 31 $42 call | out-of-money | 6/17/20 | 1.60 | 7/31/20 | 1.60 | 4.03% | |
| ABBV Sep 18 $100 call | out-of-money | 7/15/20 | 4.60 | 9/18/20 | 4.60 | 5.05% | |
| IIPR Sep 18 $100 call | in-the-money | 7/22/20 | 5.00 | 9/18/20 | 5.00 | 5.69% | |
| QCOM Sep 18 $95 call | in-the-money | 6/24/20 | 4.30 | 9/18/20 | 4.30 | 4.82% | |
| USB Sep 18 $37.50 call | in-the-money | 7/22/20 | 2.00 | 9/18/20 | 2.00 | 5.52% | |
| BIP Oct 16 $45 call | in-the-money | 9/2/20 | 1.95 | 10/16/20 | 1.95 | 4.65% | |
| SBUX Oct 16 $87.50 call | in-the-money | 10/16/20 | 3.30 | 10/16/20 | 3.30 | 4.00% | |
| V Nov 20 $200 call | in-the-money | 9/22/20 | 10.00 | 11/20/20 | 10.00 | 4.99% | |
| ABBV Dec 31 $100 call | in-the-money | 11/18/20 | 3.30 | 12/31/20 | 3.30 | 3.62% | |
| EPD Jan 15 $20 call | in-the-money | 11/23/20 | 0.80 | 1/15/21 | 0.80 | 4.41% | |
| MO Jan 15 $40 call | in-the-money | 11/25/20 | 1.90 | 1/15/21 | 1.90 | 4.79% | |
| USB Jan 15 $45 call | in-the-money | 11/25/20 | 2.00 | 1/15/21 | 2.00 | 4.48% | |
| BGS Feb 19 $27.50 call | in-the-money | 12/11/20 | 2.40 | 2/19/21 | 2.40 | 8.96% | |
| VLO Mar 26 $60 call | in-the-money | 2/10/21 | 6.50 | 3/26/21 | 6.50 | 12.10% | |
| CVX Apr 1 $95.50 call | in-the-money | 2/19/21 | $4.30 | 4/1/21 | $4.30 | 5.02% | |
| AGNC Jun 18 $17 call | out-of-money | 4/13/21 | $0.50 | 6/18/21 | $0.50 | 3.21% | |
| KKR Jun 18 $55 call | in-the-money | 4/28/21 | $3.00 | 6/18/21 | $3.00 | 6.25% | |
| USB Jun 16 $57.50 call | out-of-money | 4/28/21 | $2.80 | 6/18/21 | $2.80 | 5.24% | |
AGNC Investment Corp. (AGNC)
Yield 8.4%
Last week’s trading hit AGNC smack dab in the chin. The flattening yield curve put the hurt on companies that benefit from a steepening yield curve, and mortgage REITs along with regional banks are front and center. After moving consistently higher for more than a year, AGNC fell more than 10% in six trading days. But the stock has been recovering for the past couple of days. The huge dividend is still rock solid. And last week’s market was likely an overreaction. There will be a damper on the story until the yield curve starts to steepen again. But it’s still a good income play that now sells at a good price. BUY
Brookfield Infrastructure Partners (BIP)
Yield 3.8%
The infrastructure partnership pulled off the recent high a little bit. But the uptrend is still very much intact. The upward trend isn’t a thing of beauty, and it can be hard to notice. It’s very gradual and choppy. For example, after the recent blip BIP is only up about 1% since the middle of January. It tends to move higher and then bounce around in the higher range for a while. But it’s moving in the right direction and has a lot going for it. Earnings are growing and the infrastructure sector is in the news and getting more attention. BIP isn’t sexy. But it’s good. BUY
Digital Realty Trust, Inc. (DLR)
Yield 3.0%
DLR got caught up in last week’s selling as REITs came under pressure in the revised interest rate story. After making a new all-time high, it pulled back 6% in six trading days. There is still good reason to be skeptical that last week’s action represents a new trend. And the recent moves are typical of the choppy trading in DLR. I think this solid growth niche REIT is highly capable of shaking off this latest bummer and renewing its ascent. HOLD
Enterprise Product Partners (EPD)
Yield 7.5%
Midstream energy companies were another casualty of last week’s trading, The inflation trade got creamed and the energy sector tumbled. The midstream subsector fell in sympathy even though these companies aren’t levered to commodity prices. EPD fell about 6% last week after climbing to a new recent high. I expect the stock to creep back after last week’s hysteria likely fades. The huge dividend is safe and the stock is still cheaply valued and trending in the right direction. BUY
NextEra Energy Inc, (NEE)
Yield 2.1%
This combination alternative energy utility stock actually benefitted in last week’s market. I’m not sure what the logic was there but I like the stock going forward. This is a rock-solid, high-growth utility that enables investors to play the clean energy trend in a conservative way. I expect investors to renew their lust for this stock as clean energy gets more attention in the new administration. It may wallow for longer. Alternative energy stocks are out of vogue now. But they’ll come back. Patience should pay off. BUY
ONEOK, Inc. (OKE)
Yield 6.7%
Recent action in this midstream energy stock mirrors EPD, except to a greater extent because OKE is more volatile. It fell 7% last week but gained most of that back (4.85%) on Monday as investors sobered up. OKE had made a new post-pandemic high after trending higher since November. Last week’s action likely just represents a small blip in the continuing uptrend. Business is booming while OKE still trades a long way from the pre-pandemic high. I expect it to continue moving higher. BUY
Qualcomm (QCOM)
Yield 2.0%
This well-positioned 5G chip maker still can’t get out of its own way. Even when the market changes personality, the new guy doesn’t seem to like QCOM either. But Qualcomm is a huge beneficiary of the 5G rollout, as the company earns royalties in its 5G smartphone chip. The good times should last a while. In the meantime, QCOM sells at just 16 times earnings ahead of 5G becoming a bigger story in the market after the pandemic. QCOM could bounce around for a while longer but it could be a big winner the rest of the year. BUY
U.S. Bancorp (USB)
Yield 3.0%
Even when the cyclical rally petered out and financial stocks consolidated, this best-in-class regional bank stock hung tough near the highs. But recent action tanked the stock. It’s down almost 10% in June, and most of that fall came in couple of ugly days last week as yield curve stocks took a beating. But the bank will surely benefit from the booming economy, and the yield curve may steepen from here through the rest of the year. The pullback enabled us to keep the stock as it fell below the strike price on options expiration. HOLD
Existing Call Trades
AGNC June 18 $17 call at $0.50 - Expired
Your stock may have been called since the calls were written, despite the fact that the stock closed out-of-the-money on expiration, as many investors sought to exercise the option so that they could collect the monthly dividends. If your stock was called you got a total return of about 17% in less than five months. If not, you got the income return below and still hold the stock.
- Call premium: $0.50
- Dividends: $0.60
- Total: $1.10 (total income return of 7.1% in 5 months)
KKR June 18 $55 calls at $3.00 – Expired and Called
It happens. We target a price that can reasonably be reached by expiration in order to get a high call premium. I do like the stock for between now and the end of the year. But you got a better than 20% total return in just three months since the position was initiated in the portfolio.
- Call Premium: $3.00
- Dividend: $0.145
- Appreciation: $7.02 ($55 strike price minus $47.98 purchase price)
- Total: $10.165 (total return of 20.75% in 3 months)
Sell USB June 18 $57.50 calls at $2.80 – Expired
The stock had a nice move higher after we wrote these calls and hovered well above the strike price through almost the whole tenure of the call. But bank stocks had a big selloff last week and USB fell below the strike price by expiration. It’s still a good stock to own despite last week’s overreaction and we can write more calls in the future. Here’s the income return so far.
- Call premium: $2.80
- Dividend: $0.42
- Total: $3.22 (total income return of 6.3% in 3 months)
Sell DLR July 16 $155 calls at $8.00 or better
These calls never reached the target price since the update was published last Wednesday. DLR got caught up in the selling last week. The stock fell 5% between Tuesday and Friday. It bounced back on Monday, but the calls are still priced well below the target at $3.50. We’ll leave the order for another week or two in case DLR continues to recover.
Income Calendar
Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Income Advisor for an explanation of how dates are estimated.
The next Cabot Income Advisor issue will be published on July 28, 2021.
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Chief Investment Strategist: Timothy Lutts
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