Devon Energy (DVN) put options look attractive to short put investors as a bullish income play, as described in my article last month on DVN stock. Assuming free cash flow for Q4 does not come into significantly lower, shorting DVN puts again for February expiration continues to look attractive.
Devon Energy pays a complicated two-part dividend, as I described in my last article. The fixed amount is 18 cents per quarter, and the variable amount last quarter, representing 50% of net free cash flow (FCF) after dividend payments was $1.17, or $1.35 in total.
That means that the annualized dividend is $5.40 per share, and at today’s price (Jan. 9 midday) of $62.18, the dividend yield is 8.68%. However, if FCF during Q4 is lower than Q3, which is likely the new dividend will be lower and the yield will be lower as well.
So, for example, if FCF comes in 10% lower, the variable dividend will be around $1.05, and with the fixed dividend portion of 18 cents, the new quarterly dividend will be $1.23. That gives it an annualized yield of 7.9% (i.e. $4.92/$62.18). Assuming the stock stays at an 8.68% yield, the price has to fall to $56.68 (i.e., $4.92/.0868 = $56.68).
We can use that to set up a new put option short-income play scenario.
Shorting Puts for Income
For example, the Feb. 3, 2023, put option chain shows that the $54.00 strike price, well below our target price of $56.68, trades now for about 46 cents per put contract. That works out to an immediate yield of 0.85%, or 10% on an annualized basis, assuming the investor can get to short puts at this strike price each month.
That also means that the investor will not have to purchase shares in Devon until it falls to $54.00 per share. But even if that happens the investor gets to buy a stock with an even higher dividend yield. For example, assuming the dividend falls to $4.92, the $54.00 strike price implies a 9.11% dividend yield for the short-put investor.
In other words, this strike price has a very good implied dividend yield for the long investor. Moreover, given that the investor already received $0.46, the breakeven point is actually $53.54 per share. That implies an even higher dividend yield of 9.2%.
So, in a sense, the bullish short put investor has a good deal of confidence shorting out-of-the-money puts for this high-yield dividend stock. Last month, as I wrote in my article, the investor could have shorted DVN put options at $57 and $54 strike prices and completely kept those premiums. I suspect that the same thing will happen this coming month for investors who short puts with the Feb. 3, 2023, expiration period.
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On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes.