Do not pass go. Do not collect $200.
Okay, we aren’t talking about Monopoly, but I like this photo.
Dividends…the yield-seeking investor’s dream. Get paid to hold the stock. Cash in the account. We get all that.
Here at Stony Brook Securities, we almost never look at the dividend of anything we are investing or trading in because we are looking for liquid opportunities and do not feel a dividend gives us a better chance of making money. So we simply don’t look at it.
In a consulting session last night I was asked about a stock called Frontier Communications Corporation (FTR) and specifically the FTR dividend. I did some research on the FTR dividend and the stock itself and am going to share my thoughts on it all. Sit back and relax, this is going to be an in-depth analysis of FTR, the FTR dividend, and how I look at situations like this one.
Frontier Communications Corporation (FTR)
Before we get into the FTR dividend, I want to go through how I analyze a stock like this. You will notice that we never look at any numbers, business plan, balance sheet, or analyst reports because none of that matters to us…at all.
Before thinking about what trade or investment we want to make, we need to make sure there is proper liquidity in the asset we are considering. It is binary. If an asset is liquid, we can make one of a dozen types of trades in it. If the asset is not liquid, we will not trade or invest in it and in fact, we will take it off our watch list and remove it from our memory because it is no longer important to us.
The two things we look for when considering if an asset is liquid or not are the following:
- Stock liquidity
- Options liquidity
If both the stock and options are not liquid, then we are like the Monopoly guy. We say, do not pass go. We walk away.
FTR Stock Liquidity
Let’s jump right in. When checking stock liquidity, we must look for two things:
- Bid/ask spread a few pennies wide at the most
- Volume in the millions
If these two things are true, we can say an asset has stock liquidity. Here we go.
FTR is a penny stock (we will get to that later). However, we can see the bid/ask spread in the photo above is only $0.01 wide. It does not get better than this. When we see a bid/ask spread this small, we know there is competition for shares. The more competition there is, the better prices we can get. Excellent.
Next, we move on to stock volume with the hopes of seeing something in the millions. What do we see?
Nice! We can see over 72,000,000 shares were traded yesterday.
With the combination of the stock bid/ask spread being one penny wide and the total volume being over seventy million we can say that FTR has high stock liquidity.
We are now halfway there!
FTR Options Liquidity
Similar to checking stock liquidity, we also have a checklist for options liquidity that goes as follows:
- Volume in the thousands
- Monthly and weekly expiration cycles
- Bid/ask spreads no wider than a few pennies
- Open interest in the thousands
Just like our stock liquidity checklist, if these four points do not check out we must walk away. Even if the stock liquidity is there, but the options liquidity is not, we walk away as both are crucial to our overall success.
Let’s jump right in.
Volume in the thousands?
Monthly and weekly expiration cycles?
Nope. Here we only see the monthly options expirations. If we were to see weekly expiration cycles here, it would be because there was enough demand for them. But there is not. Remember, demand created competition and thus gives us better prices.
How about the bid/ask spreads for some of these options?
Awesome. Those look reasonable to us. Especially because you can get filled at pretty much any size in here.
Now only to final check, do we see open interest in the thousands?
We certainly do! We can see six out of the eight contracts here have an open interest in the thousands. The reason open interest is something we look at is that it shows that people are placing sizeable bets on certain prices. This tells us that there are more than just retail investors active.
For a penny stock, we can say FTR options are as good as they are going to get.
And with this, we can say that FTR is liquid enough for us to trade. Espescially considering our plan here is to make an actual investment rather than trade in and out of the product.
What Are We Going to Do About This FTR Dividend?
Remember, we think dividends are a joke. However, we believe that the FTR Dividend presents us with a unique opportunity.
According to Yahoo Finance, the FTR dividend is currently $0.42. As of writing this article, FTR is current trading for $2.00 a share (penny stock). However, at the current prices, the FTR dividend yield is about 21%. That is incredibly large.
However, people get suckered into this concept far too often. People get obsessed with the dividend yield when a dividend is nothing more than a dividend per share in form or a set value ahead of time.
When FTR was back at $5.75 a share in May, the dividend per share was still $0.42 making that dividend yield that everyone gets so excited about only 7.3% (which is still really high compared to almost every other stock in the world).
Here are the dividend payouts over the last two years:
How We View the FTR Dividend
This stock is clearly on the low end of its range. And when stocks are down…we buy them!
We have mentioned a few times that we typically stay away from penny stocks. However, at Stony Brook Securities, our students look at opportunity vastly different than any other group of traders. Here is how we break it down.
The stock is on its butt. If we are going to do anything here, we must first see if it is liquid enough. We showed above that it is liquid enough.
And since it is liquid enough and on the low end of its range, we would like to go long FTR.
If we buy it right now at $2.00 and hold it for a year, we will receive $0.42 in dividend payments spreads across four quarterly payments of the FTR dividend consisting of $0.105 each. This cash value will be taken out of the stock and credited to our brokerage account in the form of cash payments.
99.99% of investors will stop there. But we will not. We know that we are going to receive 21% in our initial investment because of the FTR dividend. But we want MORE.
We will be able to get more by selling a call against our stock position with an expiration of one year from now. This way we will guarantee we collect the $0.42 over the next year.
Covered Call in FTR
To do this, we buy 100 shares of FTR at $2. That means me paid $200 for this.
We will collect $42 over the course of the next year in the form of the FTR dividend. That is equivalent to 21% of our initial investment.
We are going to sell the $2 call and collect $.35 for doing so. We can add that credit of $35 to the FTR dividend credit of $42, and we have already set ourselves up to collect $77 over the course of the next year.
Instead of just getting 21% on our money through only the FTR dividend, we are now able to get 38.5% on our money over the course of the next year in credit. Wow!
We will make 38.5% on our money if FTR is above $2 one year from now while at the same time this position is profitable as long at FTR finishes above $1.23 one year from now.
Wrapping it All Up
There was a lot here, so let’s break it down. What exactly did we do here?
- Before doing anything, we checked to see if FTR had enough stock and options liquidity. It did.
- We know that the FTR dividend ($0.42) will yield us 21% on our original investment as the current price of $2.00 per share.
- We aren’t regular passive or inactive investors, and we will sell the $2 call that expires one year from now and collect another $0.35 per share.
- By buying 100 shares of FTR at $2 a share, we spend $200. Over the course of the next year, we receive $42 with the FTR dividend which represents a 21% ROI. On top of this, we will sell the $2 call expiring one year from now and receive another $35 in credit.
Combined, this trade allows us to receive 38.5% ROI on our original investment over the course of the next year. Sign me up for that!
P.S. If you have enough capital to have a portfolio margin account, the margin requirement for buying $100 shares of FTR is only
$30. And since we can do the same investment, instead of making 38.5% on a $200 investment, we would be looking at a 256% ROI!!!