Strategy To YieldBoost Fred's From 3.4% To 30.4% Using Options

Shareholders of Fred's Inc. (FRED) looking to boost their income beyond the stock's 3.4% annualized dividend yield can sell the January 2018 covered call at the $7.50 strike and collect the premium based on the 65 cents bid, which annualizes to an additional 27% rate of return against the current stock price (at Stock Options Channel we call this the YieldBoost), for a total of 30.4% annualized rate in the scenario where the stock is not called away. Any upside above $7.50 would be lost if the stock rises there and is called away, but FRED shares would have to climb 5% from current levels for that to happen, meaning that in the scenario where the stock is called, the shareholder has earned a 14.1% return from this trading level, in addition to any dividends collected before the stock was called.

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In general, dividend amounts are not always predictable and tend to follow the ups and downs of profitability at each company. In the case of Fred's Inc., looking at the dividend history chart for FRED below can help in judging whether the most recent dividend is likely to continue, and in turn whether it is a reasonable expectation to expect a 3.4% annualized dividend yield.

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Below is a chart showing FRED's trailing twelve month trading history, with the $7.50 strike highlighted in red:

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The chart above, and the stock's historical volatility, can be a helpful guide in combination with fundamental analysis to judge whether selling the January 2018 covered call at the $7.50 strike gives good reward for the risk of having given away the upside beyond $7.50. ( Do most options expire worthless? This and six other common options myths debunked). We calculate the trailing twelve month volatility for Fred's Inc. (considering the last 251 trading day closing values as well as today's price of $7.13) to be 91%. For other call options contract ideas at the various different available expirations, visit the FRED Stock Options page of StockOptionsChannel.com.

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