Dividends have attracted investors for decades, and trading options on dividend aristocrats offers a smart way to benefit from their stability. By examining historical dividend yields, you can strategically set up trades. Plus, we’re sharing with you our free backtesting tool to confidently assess past performance and enhance your trading decisions.
Key takeaways
- Trading dividend aristocrats using options can be a strategic way to capitalize on their consistent performance and historical dividend yield.
- By analyzing the historical dividend yield of these stocks, you can identify opportunities to set up options trades and have a sort of “floor” value represented by the dividend in case of stock assignment.
- We provide a free backtesting tool to evaluate how dividend aristocrats have performed in the past based on their dividend yields, helping you make confident and informed trading decisions.
What Are Dividend Aristocrats (and How Do They Affect Your Investment?)
There’s a good chance you have already encountered the “dividend aristocrats” term in the past. For those who are not familiar, dividend aristocrats are elite companies that have consistently increased their dividends for at least 25 consecutive years.
These companies are often large, well-established firms known for their stable earnings and strong financial health. Investing in dividend aristocrats can be a solid strategy, especially for those seeking reliable income through dividends.
Why Dividend Aristocrats Matter
Dividend aristocrats hold a special place in the hearts of many investors due to their long history of rewarding shareholders with regular income. This consistent track record is a testament to the company’s ability to generate profits and manage their finances effectively.
As a result, these stocks are often seen as safe bets, particularly in volatile markets. Their robust performance can also provide a cushion against market downturns, making them an attractive option for conservative investors.
Evaluating Historical Dividend Yields
When considering investment in dividend aristocrats, analyzing historical dividend yields can be quite revealing. By examining the dividend history, investors can gauge a company’s commitment to returning value to shareholders.
This data can help identify patterns of growth and stability and inform better trading decisions. Historical yields offer insights into how the company might perform in the future, giving investors the confidence to make informed choices.
Options Strategies with Dividend Aristocrats
While dividend aristocrats are solid investments on their own, leveraging options strategies can enhance their benefits. Note that most options strategies generally do not require to hold stocks (with a few exceptions, as we explain below).
Nevertheless, options traders can always face the risk of stock assignments under particular market scenarios, and being assigned stocks from a dividend aristocrat can constitute an interesting cashflow over the years. In fact, this dividend can act as a sort of “return floor” for your option strategy.
Here are a couple of options strategies that investors often use on dividend aristocrats:
- Covered Calls: This strategy involves holding a long position in a stock and selling call options on the same stock. It allows investors to earn additional income from the premiums collected, making it a great way to boost returns on dividend aristocrats. However, it’s important to note that while you gain income through premiums, you might forego potential upside if the stock price rises above the strike price.
- Married Puts: This strategy involves buying put options while holding shares in the same stock. It acts as an insurance policy against a decline in the stock’s price. Although you pay a premium for the puts, it protects your investment by limiting potential losses. This can be particularly useful for dividend aristocrats if you want to ensure your long-term investment isn’t adversely affected by short-term market fluctuations.
You could also use strategies that do not require to hold stocks in the first place. For instance, selling puts may ultimately lead to stock assignment. This is not the desired outcome, but knowing that the stocks you’ll receive will give you the right to earn an increasing dividend over time can provide some peace of mind. In fact, our example later in the text will focus on this latter strategy.
Note that you could also make the best out of the assignment scenario, thanks to the wheel strategy. With the wheel strategy, you retain the shares, ensuring you receive the dividend, and you sell a call, creating two income streams.
Gain an Edge When Selling Puts on Dividend Aristocrats – Our Main Idea
We often tell you that, before writing these blog articles, we are option traders ourselves. All the backtests we run are conducted because we are interested in checking the reliability of a strategy for ourselves.
If we like the results, we share the analysis output, letting you run your own backtest. Therefore, here is the idea we had in mind: selling puts on dividend aristocrats with a strategic twist.
The Idea We Wanted to Test
Let’s consider a scenario: you sell a put on a dividend aristocrat that’s currently trading at $100. The put has a $90 strike price and expires in a month. Then, unexpected negative news hits, and the stock price drops below $90 by expiration. As a result, you end up purchasing 100 shares of the company at $90.
Now, let’s talk about the dividend yield, which is the ratio between the dividend paid and the stock price. Suppose the yield is 5%. Ironically, while a high dividend yield might seem appealing, it usually signals that the stock price has dropped—hence, why the yield appears attractive.
Here’s where the twist comes in: starting your trade when the dividend yield is high can actually work to your advantage. A high yield suggests that the stock price is relatively low, so not only do you benefit from a potentially higher dividend, but there’s also the opportunity for the stock price to rebound, allowing you to profit from the appreciation.
However, once you’re in the trade, you don’t want the yield to keep climbing. If it does, that usually means the stock price is continuing to drop—a scenario you’d want to avoid. Ideally, you want to enter when the dividend yield is high, locking in a favorable starting position, and then see the stock stabilize or recover.
Why This Matters
- Risk Management: When selling puts on dividend aristocrats, you’re essentially positioning yourself to potentially acquire high-quality stocks at a discount. But there’s more to it. Risk comes in two forms: market volatility (where the stock price drops) and the more severe scenario where a company’s value plummets to near zero. By analyzing the dividend yield relative to its historical patterns, you can gauge whether a further price drop is likely. Additionally, dividend aristocrats have a track record of increasing dividends for over 25 years, which underscores their stability. While this isn’t an ironclad guarantee, it significantly reduces the likelihood of catastrophic losses, offering a layer of protection.
- Potential Income: Selling puts on dividend aristocrats isn’t just about capturing premium income; it’s about creating multiple income streams. These stocks regularly pay dividends, providing a consistent income. When you combine this with an income strategy like selling puts, you potentially add another layer of revenue. This dual-income approach leverages both the stability of dividends and the immediate cash flow from option premiums.
- Dividend Yield Analysis: Analyzing historical dividend yields isn’t just a backward-looking exercise; it’s a tool for smarter trading. By understanding where the current yield falls within its historical range, you can identify an approximate ceiling and floor for the stock’s performance. This insight allows you to make more informed decisions, trading within a range that reflects the company’s long-term stability and potential.
Tools to Help You
Our options screener is designed to help you check strategies on dividend aristocrats. It provides the company’s current dividend yield, which is crucial for making informed decisions.
Additionally, our free backtest feature, which we’ll discuss in the next section, allows you to adjust the dividend yield threshold and evaluate the past performance of these companies. This data is invaluable as it helps you determine if the stock aligns with your investment goals.
Using these tools, you can:
- Identify Opportunities: Screen for dividend aristocrats with favorable historical dividend yields.
- Run Backtests: Look at how the dividend and the dividend yield of a company evolved over time to give better context to your trade.
- Make Informed Decisions: Use the analysis from Samurai to guide your trading strategies.
Using Our Backtest File
Let’s turn our attention to an example, as it will surely simplify how to use our backtest file for trading options on dividend aristocrats. This step-by-step guide will walk you through finding and evaluating a trade idea, using Chevron Corporation (CVX) as our example.
Step-by-Step Guide to Using the Backtest File
Using our backtest file is easy, as we tell you in the step-by-step instructions below.
Step 1. Find a Trade Using the Scanner
Start by heading over to our options scanner. You’ll find various scans available, but for this example, use the “Sell high prob puts on Dividend Aristocrats – If assigned return will be more than 4%” scan.
Within the scan results, let’s say you identify a promising opportunity with CVX. At the time of writing, CVX is trading at $160.23, boasting a dividend yield of 4.12%. In this case, you could sell a $157.5 put expiring in 2 weeks.
This is what your P&L would look like:
In the chart above, a few aspects should pick your attention:
- Your breakeven point will be $156.10 (i.e., the strike price minus the put’s cost)
- Your maximum profit will be capped to the option’s premium, which is $144
- Below $156.10, your losses will accumulate and increase linearly
The idea is the following: you should be looking for a naked put that can give you a relatively high chance of profit. And if you don’t manage to have a profit, you should feel comfortable with the idea of owning shares that pay a good dividend. Note that our fundamentals score for CVX is a solid 9 out of 10, indicating strong company health and stability—key factors when considering selling puts on dividend aristocrats.
Step 2. Entering Details in the Backtest
With your trade idea in mind, it’s time to input the necessary details into the backtest file to see how this strategy might have performed historically:
- Ticker: Enter “CVX” as the ticker symbol.
- Dividend Yield Threshold: Use the yield mentioned in the scan, which is 4.12%.
- Starting Year: The default setting in the backtest file is 2010. Feel free to adjust this if you want to explore different time frames.
Therefore, this is what your backtest input should look like:
3. Evaluate the Output
You are now ready to evaluate how often CVX’s yield exceeded the threshold and what implications this has had in the past.
- Analyze Results: Once the backtest runs, you’ll receive data that shows historical performance metrics. This will include how often the dividend yield was above your set threshold and the potential outcomes of similar trades.
- Prepare for Next Steps: This section is just the beginning of your analysis. In the following section, we will look at how you could interpret these results, discuss what they mean for your investment strategy, and how they can inform your decision-making process.
Real Life Example: The Typical Output of our Dividend Aristocrat Backtest
So, let’s look at the output of our analysis using Chevron Corporation (CVX) as an example. With a dividend yield of 4.12%, our backtest provides insightful data points that are key for making informed trading decisions.
Backtest Results
The first result you will see is the following:
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- Percentage of Cases Above 4.12%: In our analysis, the annual dividend yield of CVX was above 4.12% in 87.50% of cases. While this might initially seem positive, it actually suggests that a yield above this level is quite common. This means that the stock price could still have room to drop further, as the yield tends to be high when the price is low. Rather than jumping in, you might want to wait for a better entry point—closer to the “floor”—where the stock is less likely to experience further declines.
- Minimum Annual Dividend Yield: The lowest yield recorded was 3.40%. Even at its minimum, CVX maintained a respectable yield, showcasing its stability as a dividend aristocrat.
- Maximum Annual Dividend Yield: The highest yield reached was 8.34%, corresponding to a period in which the denominator in the dividend yield calculation (i.e., the stock price) declined significantly. Note that, in general, you want the dividend yield to increase before you enter a position, and decline once your trade is open (because it generally means that the stock price moved upwards).
- Average annual dividend yield: With an average of 5.22%, the current dividend yield (4.37%) is below the average, indicating that the stock price may have room to decline.
Understanding the Charts
Our analysis includes a couple of charts to help you evaluate the situation more visually:
In these charts, the blue line represents the cumulative dividend, which is a rolling sum over four quarters. This line provides a clear view of the trend in dividends, generally showing an upward trend, consistent with what you’d expect from dividend aristocrats. However, the red line, which represents the dividend yield, fluctuates based on changes in the stock price.
These fluctuations present an interesting dilemma:
- Long-Term Perspective: If you look at the entire historical range, you’ll notice that the yield has been below the current level about 80% of the time. From this vantage point, the analysis might suggest that this isn’t a particularly strong opportunity right now, as there could still be room for the stock price to decline further, pushing the yield even higher.
- Post-COVID Perspective: On the other hand, if you focus on the period after 2021, post-COVID, you’ll observe that the yield has settled into a new, higher range. This shift could indicate that what we’re seeing now might represent a new “floor.” In this case, the current yield could signal an opportunity, suggesting that the stock price might stabilize or even increase from here. You should consider each company’s business evolution over time to continuously assess and reassess where the real “floor” stands.
Ultimately, whether this situation represents a good opportunity depends on your perspective. It’s important to remember that you generally want the dividend yield to be high before you enter a trade—not after. A rising yield post-entry typically means the stock price is falling, which isn’t ideal. Timing your trade when the yield is already elevated could allow you to benefit from both the high dividend and potential stock price recovery.
Strategy Implications
Based on these insights, you might consider keeping shares of CVX in your portfolio if they are assigned to you after selling puts. This can be an effective way to leverage the stability and growth potential of dividend aristocrats like CVX. One strategy that aligns well with this approach is known as the wheel strategy, which allows you to generate consistent income while managing risk.
Here’s how the wheel strategy works:
- Sell Puts: You start by selling puts on CVX. If the stock price falls below your strike price at expiration, you’ll be assigned the shares, effectively purchasing them at a potentially discounted price.
- Sell Calls: Once you own the shares, you can then sell call options on them. By doing so, you earn premiums, which provide an additional income stream on top of the dividends you’ll receive from holding the shares. If the stock price rises above the strike price of the call, your shares may be called away, but you keep the premium and any price appreciation up to the strike price.
This strategy capitalizes on the key strengths of dividend aristocrats: stability and consistent dividend payments. By combining the wheel strategy with a careful analysis of historical dividend yields, you can make more informed decisions and potentially achieve more reliable income streams.
We’ll be adding a more detailed article on the wheel strategy at the end of this piece, which will provide you with further guidance on how to implement this approach effectively.
Methodology and Limitations: What Dividend Yields Tell You (and What They Don’t Tell You)
Before leaving you, it’s very important to discuss the limitations of using dividend yields in your investment strategy, especially when dealing with dividend aristocrats. These elite companies are known for their consistent dividend payouts and strong performance, making them a favorite for investors seeking stability. However, understanding the limitations of relying on historical dividend yields is crucial.
While historical dividend yields offer significant insights, there are limitations and risks associated with relying solely on this data, particularly when selling puts:
- Market Changes: Past performance does not guarantee future results. Economic conditions, market dynamics, and company-specific issues can alter future dividend payments.
- Company-Specific Risks: Even companies with a strong history of dividend payments can face unexpected challenges that impact their ability to maintain payouts.
- Volatility in Yields: Dividend yields can fluctuate with stock prices, meaning a high yield might result from a declining stock price rather than an increase in dividend payouts.
Maturity and Obsolescence: Because these companies are often mature, there is a risk that they may eventually become obsolete in the face of technological advancements or changing market conditions. Even well-established firms can lose their competitive edge over time, impacting their ability to continue generating reliable dividends.
