Devon Energy Stock Is Down, Making Its High Yield and Short Put Plays Popular

Devon Energy (DVN) stock is well off its highs and down over 12% in the last month to $46.35 in early trading on March 20. This is making its high dividend yield and deep out-of-the-money short put option plays popular with investors.

The company paid an 89 cents dividend last quarter, but most of that (69 cents) was based on 50% of its excess free cash flow (FCF), as I explained in my last article on Feb. 17. So, even assuming in a worst-case situation that FCF is down 25% this quarter, investors can expect at least a 52 cent variable dividend, based on a 25% hit to FCF. This is on top of the 20-cent quarterly fixed dividend (i.e., $0.72 total). 

That works out to $2.88 annually ($0.72 x 4), giving DVN stock a 6.21% dividend yield ($2.88/$46.35). But, again, that assumes a catastrophic 25% decrease in FCF in FCF this quarter. So far this quarter crude oil is down about 17%, but much of that has happened in the last several weeks. Nevertheless, it's good to be conservative, so assuming a 25% cut in FCF still gives DVN stock an attractive 6.21% yield.

Shorting Out-of-the-Money Puts

Moreover, now investors are flocking to shorting out-of-the-money puts in order to both pick up extra yield, as well as a potential cheap buy-in price. For example, the April 14 expiration put options, just 28 days from now, show that the $38 strike price is attractively priced. This strike price is 18% below today's price, but the premium that can be received is 37 cents.

That works out to an attractive put-to-strike price yield of about 1% (i.e., ($0.37/$38.00) x 100=0.97%).

This means that an investor who secures $3,800 in cash and/or margin with their brokerage firm, can then enter in an order to “Sell to Open” 1 put contract at $38.00. The account will immediately receive $37 per put contract shorted this way. So in the next 28 days, their return is at least 1.0%, and if it can be repeated over the next 12 months, the annualized yield is 11.68%. 

Granted, the stock could rise from here, especially if the FCF decrease in Q1 is not as bad as investors fear. That means the short-put investor will not get to own the stock. Keep in mind, though, that often the investor will end up owning the shares from previous short-put plays. For example, based on our last article, investors might have shorted $50 strike price puts for expiration on March 17. Since the stock ended below $50, those investors now own shares at $50. 

Now they can either sell those shares (at a loss), which is never worth doing in this kind of trade, or they can short out-of-the-money calls. For example, the $55.00 calls for April 14 trade for 22 cents at the midpoint. That works out to an income yield of about 47 basis points, or 5.63% annually. Given that they would have received 65 cents in the short put play last month, combined with the upcoming 72 cents dividend and the 22 call premium (i.e., $1.59 total), the investor's breakeven is now $48.41.

Then, by shorting the $38.00 puts, the investor can lower that breakeven to just $48.03. The bottom line here is the investor will be able to hold this stock for the long term, and by shorting more out-of-the-money puts, they can potentially lower their average buy-in cost.

• Markets Today: Stocks See Boost From Credit Suisse Takeover But Banking Concerns Continue
• Option Volatility And Earnings Report For Mar 20 - 24
• Stocks Set To Open Lower As Investors Await Fed Meeting, Banking Sector Remains In Focus
• Bank Headlines, the Fed and Other Things to Watch this Week