Investors eyeing a purchase of Xylem Inc. (XYL) shares, but tentative about paying the going market price of $27.59/share, might benefit from considering selling puts among the alternative strategies at their disposal. One interesting put contract in particular, is the April 2014 put at the $25 strike, which has a bid at the time of this writing of 70 cents. Collecting that bid as the premium represents a 2.8% return against the $25 commitment, or a 5% annualized rate of return (at Stock Options Channel we call this the YieldBoost).
Selling a put does not give an investor access to XYL's upside potential the way owning shares would, because the put seller only ends up owning shares in the scenario where the contract is exercised. And the person on the other side of the contract would only benefit from exercising at the $25 strike if doing so produced a better outcome than selling at the going market price. ( Do options carry counterparty risk? This and six other common options myths debunked). So unless Xylem Inc. sees its shares fall 8.9% and the contract is exercised (resulting in a cost basis of $24.30 per share before broker commissions, subtracting the 70 cents from $25), the only upside to the put seller is from collecting that premium for the 5% annualized rate of return.
Interestingly, that annualized 5% figure actually exceeds the 0.4% annualized dividend paid by Xylem Inc. by 4.6%, based on the current share price of $27.59. And yet, if an investor was to buy the stock at the going market price in order to collect the dividend, there is greater downside because the stock would have to lose 8.93% to reach the $25 strike price.
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