by Lawrence Meyers | March 12, 2013 10:52 am
Business development companies offer two terrific ways to boost income for those seeking some hefty distribution payments.
BDCs must pay out 90% of their annual taxable net income each year. That has traditionally resulted in 10%-plus dividends. For the most part, BDCs provide customized debt and equity financing to lower middle-market (“LMM”) companies with annual revenues of $10 million to $100 million that operate in diverse industries. BDCs invest primarily in secured debt instruments, equity investments, warrants and other securities of LMMs.
Most BDCs distribute their income on a monthly basis, as opposed to traditional dividends, which are paid out quarterly. You can potentially enhance that payout by using covered calls.
Under this plan, you buy a BDC, then sell a covered call at the nearest strike and collect that premium. Along the way, you collect the monthly distribution. Now, the stock will fall by the same amount of the distribution on the ex-dividend date; this has been factored into the option premium by the market already. However, if possible, you’ll want to sell the call for the expiration date that comes after that ex-dividend date. That’s usually two to three weeks out, which gives the stock an opportunity to rise after the distribution discount, but its not essential to the strategy.
Let’s take Main Street Capital Corporation (NYSE:MAIN) as an example. The stock trades at $34. Ex-dividend dates usually fall mid-month, so let’s aim for the April expiration date and the $35 strike. Say you buy 500 shares of the stock for $34, and get charged an $8 commission. You then sell the April 35 Calls for 35 cents each, and a $13 commission. That’s a $154 net credit. Around March 18, MAIN is expected to pay you 15 cents per share, giving you a net credit now of $229.
April expiration will fall on April 19, which is about the same time as the next distribution occurs, so you’ll pick up another $75 for a total of $304 on the trade. If the stock closes at $35 or above, your shares will be called away. You’ll net another $500 in profit on the sale, less your $8 commission, for a total profit of $796. That’s a 4.86% return in just six weeks, or 42% annualized.
If the stock closes between $34 and $35, you profit $304 plus $5 for every cent above $34 the stock closed at. You may cash in then, or repeat the same strategy. If the stock closes below $34, you break even at $33.40.
While MAIN will lose the same 15 cents per share that it pays out in dividends, the thought is that the secular trend favors a rise in BDCs over the near term as investors chase that yield.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets @ichabodscranium.
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