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Income Advisor
Conservative investing. Double-digit income.

September 30, 2020

The environment for writing calls has deteriorated of late as the market uptrend has been interrupted. A market moving higher increases investors’ willingness to speculate on higher stock prices, and call premiums rise. A choppy market reduces demand and call premiums.

A New Call in an Uncertain Market

Yesterday, we sent a “Special Alert” to sell covered calls on newly initiated position Visa (V). Hopefully, you received an email yesterday afternoon. But if you didn’t see it or act on it, the Special Alert is listed below, and the call is still above the targeted price.

The environment for writing calls has deteriorated of late as the market uptrend has been interrupted. A market moving higher increases investors’ willingness to speculate on higher stock prices, and call premiums rise. A choppy market reduces demand and call premiums.

As of now, there are only two calls outstanding on portfolio positions. Four calls expired on September 18 and new ones have been slow to be initiated because of the forbidding market. That’s okay. We take what the market gives. And the environment will improve again.

That said, there are always individual exceptions to the rule. One such exception is Visa. Since it is such a highly desirable stock to own, investors are still willing to speculate on higher prices even when the market isn’t trending higher.

The current market still offers high call premiums on Visa stock. It’s worth noting that the call below is written with a strike price very near the current price. In fact, those calls are in-the-money as of now. The original purchase price was around 95 and the 200 strike price offers some capital appreciation potential if the stock is called, but not from the current price.

The reason for the in-the-money call is two-fold. One, it makes for higher call premiums. And two, I’m not confident in the market over the next couple of months. The uptrend has been broken and the market is staring at highs risks with the upcoming election and the virus.

If the market does take off and the stock is called away, you will still get a nice income return in a short time. Plus, the up market will create many more opportunities. If the market remains choppy or moves lower, you still steal a great income.

Stock Portfolio Recap

AbbVie Inc. (ABBV) Yield 5.4%—This is a fantastic pharma company. I love the fundamental story. It has one of the very best pipelines in the business that should easily overcome competition for Humira over time. The merger appears to be working. And the stock is still dirt cheap with a high and safe dividend. But the technical story is deteriorating. After rising from the March bottoms to a new 52-week high of over 100 by mid-July, the stock has floundered back to the current 88 per share. The stock needs to bounce back in the next week or two to avoid a technical red flag. BUY

Altria (MO) Yield 8.8%—It’s disappointing that the down market didn’t like this stock any better than the up market did. MO isn’t getting any love and I don’t know when it will. But the portfolio bought into the stock at a cheap price, even by the current lousy standards. As well, the high dividend is safe and we generated a nice call premium in the stock to boot. We’ll get more call writing opportunities in the future and make this a great income generator, even if the price fails to significantly recover. BUY

Brookfield Infrastructure Partners (BIP) Yield 4.1%—This infrastructure partnership has navigated the recent down market beautifully. It has been trending slowly higher for a long time. What has changed is the relative performance. It has been underperforming the go-go market by only moving higher slowly. But it continues to do its thing, even when the market turned south. It’s an attractive play in this uncertain market because it has a very defensive business and a high dividend. It has moved beyond the strike price on the outstanding call but we’ll see how things unfold over the next month. Having moved beyond the strike price I will reduce the rating to HOLD. HOLD

Enterprise Product Partners (EPD) Yield 11.2%—On an operational and fundamental basis, this stock deserves a much higher price. The business is rapidly recovering and that stratospheric dividend is safe. But tell that to today’s cranky investors. They don’t like anything to do with energy. And they probably won’t change their minds until they get slapped in the face with positive tangible results. That may occur when third-quarter earnings are announced next month. Until then, it still pays the massive double-digit income. BUY

Starbucks (SBUX) Yield 1.9%—This coffee house stock has a business that has been remarkably resilient during the pandemic and will surely boom again as lockdown restrictions ease. It pulled back with the market but has been on the rise again recently. The price is now approaching the 37.50 strike price on the calls. Whether the position gets called away or not on October 16 will largely depend on the direction of the overall market. If it gets called away, we’ll get a great income return in a short time. If it doesn’t, it will still be a great stock to own going forward. BUY

Valero Energy (VLO) Yield 9.0%—VLO is a similar story to EPD. If the recovery the market is banking on and pricing in materializes (and I think it will), this refiner will surely benefit. But investors certainly aren’t biting yet. I believe next month’s earnings report will change the sour dynamic. The pandemic hit will be behind the company and there will be only quarters of rapid earnings growth ahead. In the meantime, the high dividend is safe. BUY

Visa (V) Yield 0.60%—Visa is one of the very best large company stocks on the market to own. Payment processing is a sweet business as the world moves decidedly toward more cashless transactions. This is a stock that has returned more than 1,000% over the past 10 years. But it tends to bounce around with the market in the near term. In this update, I highlight a covered call below. The strike price is very near the current price with a high premium. The market is uncertain and I want you to generate a strong return and high income even if the market continues to bounce around over the next couple of months. BUY

Existing Call Trades

Sell SBUX October 16 87.50 call at $3.30
Although the stock price has moved close to the strike price, the current call premium is priced at just $2.70, well below the targeted price. That is because of the erosion of time value and the interruption of the market uptrend. If you did write the calls, you got a great premium and a great income during a window where the market allowed for such things. We’ll see what happens by mid-October.

Sell BIP October 16 45 call at $1.95 or higher
I think this stock is running away. It’s about $3 in the money with just a little more than two weeks to go until expiration. But I think investors are warming to this kind of defensive dividend stock ahead of the election uncertainty. It’s fine if the stock is called away. We will have used it for a double-digit income in a short time.

Special Alert on September 23, 2020

Sell V Nov 20 200 call at $10.00 or higher
Expiration date: November 20
Strike price: $200
Call price: $10 or higher

On the day of the last issue, in which Visa (V) was highlighted (September 23), the closing price was 195.37 per share. After trending down for most of September, the market has rallied for two straight days. However, there are still risks regarding the election and virus that will likely weigh on the stock for the next couple of months.

V has moved up to over 200 per share on the rally. It’s a good time to lock in a high call premium at a strike price just slightly in-the-money while the market is still in such a good mood. Here are the return scenarios assuming a 195.37 purchase price:

  1. The stock goes above $200
    • Call premium: $10.00
    • Dividend $0.30 (ex-date 11-15)
    • Appreciation: $4.63 ($200 strike price minus $195.37 purchase price)
    • Total: $14.93 (total return will be 7.6% in seven weeks)

  1. The stock price stays the same
    • Call premium: $10.00
    • Dividend $0.30
    • Total: $10.30 (total return will be 5.3% in seven weeks)

  1. The stock price declines
    • You will be down by however much the stock is down less the $10.30 from the dividend and the call. And the position will live to pay more dividends and write more calls in the future.