Earlier this morning I was sitting down updating my spreadsheets and watchlists (something I do roughly 2 to 3 times per month) and I came across an article on The Motley Fool (www.fool.ca). At first I laughed a little at the article, but as I got closer to the end I became quite concerned at some of the statements within. The article was written yesterday (January 15, 2015) by Robert Baillieul titled, How You Could Earn a 16.7% Yield From Suncor Energy Inc.
I’m not too sure what Robert’s background is (states on the website his is a contributing writer) but this article is an example of what I teach my clients to watch out for when they’re reading financial content online or listening to a talking head on TV.
The premise of the article is about using Call Options with Robert making the statement that this is a, “…little-known strategy to safely earn 10%, 15%, even 20% yields on your money.” The statements in the article are targeted to income investors specifically and although the logical response to this line is b*&%s*(@t you would be surprised how many investors will read it, see it as easy money and implement it into their investing practices.
A call option is defined as, “An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period — Investopedia”.
I don’t use call options at all as I’m a long-term buy and hold investor, but the strategy in the article is to hold the investment, collect the dividend, sell a call option and then repeat it a few times per year to generate an overall 16.7% yield from Suncor (SU).
What troubled me the most was the comment near the end, “These are safe 15% to 20% yields available right now“, “Remember, Suncor is a safe, blue-chip stock” and “Of course, there are more things you need to know to successfully sell covered calls. I’ve tried to keep this explanation as simple as possible”
Of course! Don’t bother writing an authoritative article including the pitfalls and downsides of selling covered calls….just focus on the easy money just sitting there waiting for investors to collect! (I’m not being serious)
The problem here is that there is no safe blue-chip stock. Safety is really just a measure of confidence. There are so few companies today with sustainable competitive advantages at a reasonable valuations that making this statement is dangerous and shows a lack of knowledge of the underlying risks to the strategy. I think Suncor is one of the better large cap O&G companies in Canada, but an investment in them is not full-proof, guaranteed or safe. Especially with the volatility in the price of oil, the uncertain economic impacts here in Canada and no one knowing when or where the price will stabilize.
On Tuesday (January 13, 2015) Suncor announced it was cutting 1,000 jobs and slashing its capital spending by $1 billion this year. Suncor is a well managed company and those moves are prudent in the face of the challenges it faces, but by no means does Suncor believe they are immune, protected or safe. An income investor will receive a dividend yield of roughly 3.15% given today’s current valuation, but that is not a risk free dividend and certainly not risk free to the capital you invest in order to receive that dividend.
As a long-term investor I expect Suncor to appreciate considerably over the next 10-15 years, to continue to raise its dividend and or to be bought out in an acquisition. But I am realistic in that I may only collect my ~3% dividend this year with little to no capital appreciation if oil prices don’t change. If I earn more great, but there are no short cuts to investing. You have to be cold, be calculated, be emotionless. You have to know where opportunities are good and where they are TOO good.
* Disclosure: I or my family own shares of Suncor Energy (SU) at the time of this post *
I’d wager the bigger risk said reporter failed to report is covered calls is very risky. A covered call gives someone the right to benefit from a large move up while giving you the risk for the large gap down and all for a small guaranteed sum. Maximize risk, minimize reward sounds perfect doesn’t it? The market moves in large gaps several times per year. I’ll take a pass on this strategy.