Risk Latte - Buying Commonwealth Bank Stock with Protective Put Options

Buying Commonwealth Bank Stock with Protective Put Options

Team Latte
Mar 8, 2004

One of the ideas for a dividend loving investor can be buying high dividend paying stock and buying protective put options to protect her downside (from any possible slide in the stock). The strategy should be that the dividend she receives from holding these stocks should more than offset the premium paid to buy the put options on the stock.

Two such stocks in Asia-Pacific regions are ANZ Bank and Commonwealth Bank in Australia. As of the closing option prices of 8th March 2004, Commonwealth Bank had a 12 Month Implied Volatility (Ask) of 15% and a projected dividend yield of 5.15% (Average of historical and various analysts’ estimate). Valuing on that a 12 Month ATM put option on Commonwealth Bank had a premium of 3.87% which means the spread between the (projected) dividend earned and the premium paid is 1.28%.

This is a relatively safe bet as the implied vol of Commonwealth Bank is 15% which is higher than the implied vol of the underlying S & P /ASX 200 index which is around 10% and there is a good possibility that the implied vol of the stock will fall towards the long term value of the index and that would mean an upside for the stock. Thus there is a good chance that the investor will realize a capital gain along with the dividend yield. In the worst case the investor has a downside protection, the cost of which is netted off against the dividend yield.

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