Among the universe of BDCs covered at BDC Investor, Prospect Capital Corporation (Symbol: PSEC) has stock options available as one of the tools investors can utilize to manage an investment. BDC stands for Business Development Company, and like REITs (Real Estate Investment Trusts) is a type of pass-through structure typically resulting in high dividends and therefore high yield. With most of a BDC's earnings passing through to shareholders in the form of large dividends, growth in share price is lower than it would be had those earnings been retained. This dynamic can lead to interesting opportunities to sell covered calls, as well as interesting opportunities to sell puts. This week, we will highlight one interesting put contract, and one interesting call contract, from the May 2016 expiration for PSEC. The put contract our YieldBoost algorithm identified as particularly interesting, is at the $5 strike, which has a bid at the time of this writing of 10 cents. Collecting that bid as the premium represents a 2% return against the $5 commitment, or a 4.7% annualized rate of return (at Stock Options Channel we call this the YieldBoost ).
Selling a put does not give an investor access to PSEC'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. So unless Prospect Capital Corporation sees its shares fall 22.4% and the contract is exercised (resulting in a cost basis of $4.90 per share before broker commissions, subtracting the 10 cents from $5), the only upside to the put seller is from collecting that premium for the 4.7% annualized rate of return.
Turning to the other side of the option chain, we highlight one call contract of particular interest for the May 2016 expiration, for shareholders of Prospect Capital Corporation (Symbol: PSEC) looking to boost their income beyond the stock's 15.4% annualized dividend yield. Selling the covered call at the $7 strike and collecting the premium based on the 20 cents bid, annualizes to an additional 7.2% rate of return against the current stock price (this is what we at Stock Options Channel refer to as the YieldBoost ), for a total of 22.6% annualized rate in the scenario where the stock is not called away. Any upside above $7 would be lost if the stock rises there and is called away, but PSEC shares would have to climb 8.7% from current levels for that to happen, meaning that in the scenario where the stock is called, the shareholder has earned a 11.8% return from this trading level, in addition to any dividends collected before the stock was called.
The chart below shows the trailing twelve month trading history for Prospect Capital Corporation, highlighting in green where the $5 strike is located relative to that history, and highlighting the $7 strike in red:
The chart above, and the stock's historical volatility, can be a helpful guide in combination with fundamental analysis to judge whether selling the May 2016 put or call options highlighted in this article deliver a rate of return that represents good reward for the risks. We calculate the trailing twelve month volatility for Prospect Capital Corporation (considering the last 252 trading day PSEC historical stock prices using closing values, as well as today's price of $6.49) to be 24%.
In mid-afternoon trading on Tuesday, the put volume among S&P 500 components was 759,296 contracts, with call volume at 1.42M, for a put:call ratio of 0.53 so far for the day. Compared to the long-term median put:call ratio of .65, that represents very high call volume relative to puts; in other words, buyers are preferring calls in options trading so far today.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.