master limited partnership Master Limited Partnerships

Master Limited Partnerships (MLPs) are limited partnerships that trade like stocks. They combine the tax benefits of a limited partnership with the liquidity of a publicly traded security.

MLPs typically own or process energy resources (oil, natural gas, coal) and pay relatively high and stable dividends as they sell, transport, and process energy products. Because they are a partnership they avoid corporate income tax, and can allocate a pro-rated share of their depreciation expense to shareholders' individual tax returns (you'll want to hold these in a taxable account, not a tax-deferred account).

Fortunately for covered call writers, many MLPs are optionable, too. So you can enjoy tax benefits as well as two kinds of income: high dividends and call premium.

How Much Do MLPs Pay?

The Alerian MLP Index (AMJ – an index of the 50 largest MLPs) currently yields 5.3% in dividends. That's down from 12% in early 2009 but still significantly above Treasuries.

Example Master Limited Partnerships For Covered Calls

When choosing a master limited partnership you want to look for ones that have a history of increasing dividends and that have current cash flow to more than cover the dividend payments. Two examples that have current cash flow greater than dividend payouts:

MLP Symbol EPS Div Per Share Div Yield
Alliance Resource ARLP 7.33 3.69 5.2%
Magellan Midstream MMP 3.01 3.14 5.3%

In the case of ARLP you could write an Oct 75 call for 1.25 (stock at 71.85) for an annualized return if flat (ARIF) of 19% (no earnings risk until the Nov option cycle). For MMP you can write an Oct 60 call for 1.45 (stock at 60.06) for an ARIF of over 15% (no earnings risk until Nov 2). Or, if you wanted to capture a dividend payment along with the call premium then you could write the November options for similar returns (but take earnings risk).

Risks Of Master Limited Partnerships

One thing to be aware of is that the tax advantage currently enjoyed by MLPs is potentially on the chopping block with the Obama tax increase plan. If MLPs lose their tax advantage then prices will probably go down. Although the increasing dividend yield will act as a natural brake as share prices fall. Like all investments, proper position sizing and diversification is advised.

Mike Scanlin is the founder of Born To Sell and has been writing covered calls for a long time.

Free Trial | Covered Call Newsletter | Covered Call Blog Bookmark and Share