This Dividend Payer Can Provide Income to Options Traders
Dividends are important to some investors. This may be because they think of dividends as free money. At least that’s how some papers in the academic community describe dividends.
One 1984 paper, Explaining Investor Preference For Cash Dividends by Hersh M. Shefrin and Meir Statman, explains that dividends serve as a ‘consolation’ or ‘silver lining’ when the stock declines in value. When a stock increases in value, the capital gains are thought of as a ‘super added benefit.’
The popularity of dividends explains the appeal of a number of stocks, including Lamar Advertising Company (Nasdaq: LAMR).
Lamar Advertising Company is an outdoor advertising company. The company sells advertising on billboards, buses, shelters, benches and logo plates. It owns and operates over 144,000 billboard advertising displays in 44 states, Canada and Puerto Rico.
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Lamar also delivers ads through more than 115,000 logo advertising displays in 22 states and the province of Ontario, Canada, and operates over 34,000 transit advertising displays in 15 states, Canada and Puerto Rico.
A Chart Pattern Points to Up Side in Lamar
The stock has been in a long term up trend and recently broke out to new all time highs, a bullish indicator for technical analysts.
The chart provides a price target of about $88. The target can be found based on the recent consolidation pattern in the chart above. The pattern of importance is the one that preceded the recent break out to new highs. That pattern is highlighted as a rectangle in the next chart.
This chart also shows the technique used by technical analysts to determine price targets. The target is based on the idea that market action displays a sense of symmetry. This allows technicians to estimate the potential price move after a price break out.
They assume the size of the price move after the break out will be equal to at least the depth of the pattern that formed while prices consolidated. This projection technique is shown in the chart above.
With technicals supporting additional gains in LAMR, now could be the ideal time to buy the stock. This is confirmed by fundamentals.
Lamar operates as a real estate investment trust and returns most of its free cash flow to investors as required by current tax rules. In the most recent quarter, the company reported funds from operations (FFO) of $1.40 per share, well ahead of analysts’ expectations for FFO of $1.32.
Analysts noted the results showed growth in operating income, adjusted EBITDA and cash flow from operating activities. Analysts also cited factors that should lead to continued growth in the company’s operating results:
- Stable revenues from a diverse tenant base. Customers restaurants, services, retailers and health-care companies. A significant part of the company’s revenues comes from local business.
- Robust Growth Potential in Outdoor Advertising Industry. The outdoor advertising industry has been growing as consumers spend most of their time away from home.
- Focus on Business Expansion. In the most recent quarter the company closed 13 acquisitions for a total price consideration of $91.8 million.
- Strong cash flow per share. The company generates cash flow per share of $5.33 as compared to the industry’s average of $2.27.
- Superior return on equity (ROE). Lamar has an ROE of 29%, significantly higher than the industry’s average of 5.78%.
These factors make Lamar a buy for income investors.
But the stock is expensive and the recent down move that formed part of the consolidation pattern caused the stock to become more volatile. This is generally true whether the stock has moved up or down on the big move.
Higher volatility is generally associated with higher options prices. This is because options prices reflect a number of factors. The price of a call or put option is affected by the price of the underlying stock, the current level of interest rates, the time left to expiration and the volatility of the underlying stock among other factors.
Increased volatility, when it leads to increased options prices, sets up a number of potential trading opportunities for options traders. That indicates that after a large price move, a trader doesn’t need to be concerned with whether or not the price move will be reversed.
Instead of accepting a position that depends on a directional move and can carry a great deal of risk, an options trader can establish a position with a high likelihood of success and a defined level of risk.
A Strategy to Trade Lamar Advertising
LAMR is likely to remain in a relatively narrow trading range while investors wait for news on how the restructuring is affecting the company’s bottom line. This indicates a significant move in the stock price is now unlikely after the recent bout of volatility.
When a stock is expected to remain in a narrow range for some time, it is possible to generate income from the stock. A number of options strategies could be used to meet this objective.
Among those strategies is a bull put spread. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which recently saw increased volatility and is likely to remain in a narrow range.
Source: The Options Industry Council
This strategy involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.
Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.
Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call which is to generate some income. This trade generates immediate income and carries limited risk.
For LAMR, a bull put spread could be opened with the January 19 put options. This trade can be opened by selling the January 19 $72.50 put option for about $0.90 and buying the January 19 $70 put for about $0.45
This trade would result in a credit of $0.45, or $45 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.
The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $2.50 ($72.50 – $70). This is multiplied by 100 since each contract covers 100 shares.
Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $215 ($250 – $45).
The potential gain is about 21% of the amount of capital risked. This trade will be for about four weeks and the annualized rate of return provides a significant gain.
The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy could also simplify tax reporting for investors.
These are the type of strategies that are explained and used in Trading Tips Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.