bond yield 4, Bond Yield

No Interest For 18 Months!

That's a nice offer when purchasing a new TV but it sucks when you're trying to live on fixed income investments. The Fed is serious about keeping bond yield (interest rates) low through the middle of next year. In their own words:

"The Committee agreed to keep the target range for the federal funds rate at 0 to 1/4 percent and to state that economic conditions are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."

FOMC Minutes, Aug 9, 2011

The resulting anemic bond yields make it difficult or impossible for many fixed income investors to generate enough yield to live on. Take a look at today's Treasury Yields:

Duration Yield
1 year 0.12%
3 year 0.40%
5 year 0.89%
10 year 1.97%

Corporate and munincipal bonds aren't much better:

Bond Type Duration Yield
Corporate AAA 1 year 0.52%
Corporate AAA 5 year 1.37%
Municipal AAA 5 year 1.15%
Municipal AAA 10 year 2.83%

Low Bond Yield Investment Ideas

When bond yields are as low as they are today, many experts suggest buying blue chip, large cap, dividend paying stocks instead. It's a good strategy and investors have many choices:

Number of S&P 500 stocks that pay a dividend: 396

Average dividend yield for these 396 stocks: 2.54%

An even better strategy for the risk averse, however, is to buy some of those high yielding S&P 500 stocks and write covered calls against them. Combining the call premium with the dividend yield is a good way to substitute high stock yield for low yield bonds.

Let's pick a dozen or so stocks that fit the description of "large cap, blue chip, dividend payer" and see what kind of yields are possible. For this screen we'll use: BA, CAT, GE, HD, JNJ, KFT, KO, MCD, PEP, PFE, T, UTX, and WMT. Pasting those into Born To Sell's covered call screener and then sorting by downside protection yields these opportunities for the 6+ weeks between today and February option expiration:

Symbol Stock
Sell Call Net Debit Annualized
Return If Flat
CAT 95.34 Feb 87.5 @ 9.00 86.34 15.4%
PFE 21.80 Feb 20 @ 1.89 19.91 13.0%
T 30.42 Feb 30 @ 0.70 29.72 19.5%
BA 74.56 Feb 70 @ 5.45 69.11 15.4%
HD 42.87 Feb 41 @ 2.48 40.39 12.2%
GE 18.55 Feb 18 @ 1.00 17.55 21.1%
UTX 75.19 Feb 72.5 @ 4.05 71.14 15.4%
MCD 99.49 Feb 97.5 @ 3.65 95.84 13.8%

What do these trades have in common? For one thing, they are are all in-the-money, so you are banking on the time premium portion of the call option for your profit, not any capital appreciation of the stock. Second, many have an ex-dividend date before the Feb expiration (for those that do, the dividends are included in the return calculation), and third they all pay more than 1%/month in Annualized Return If Flat. Take note that many of them also have an earnings announcement before the Feb expiration so consider carefully if you're willing to take earnings risk before investing in these.

Using a diverisifed portfolio of stocks like this and then writing calls against them is a good way to replace your low bond yield with higher yielding equity trades that have reduced equity exposure by virtue of the intrinsic value of the options you're selling. At 1%/month you are getting 6x the 10 year treasury rate. Yes, there is more risk but with diversified blue chip dividend paying stocks and in-the-money covered calls your risk should not be too great.

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