Use Options to Pile Up Yields on BDCs

by Lawrence Meyers | November 8, 2012 11:10 am

Business development companies (BDCs) have been a great place to stash cash if you’re looking for yield. That is, provided you hook up with a good one. BDCs must pay out 90% of their annual taxable net income each year. That has traditionally resulted in 10%+ dividends. The good news is that this trend is likely to continue.

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. The BDCs’ principal investment objective is to maximize the portfolio’s total return by generating current income from debt investments and capital appreciation from equity and equity-related investments, including warrants, convertible securities and other rights to acquire equity securities in a portfolio company.

LMM investments generally range in size from $5 million to $25 million. BDCs look for solid management at established companies with positive cash flow that have a defensible competitive advantage and allow for an exit strategy. They fill the gaps left by commercial banks that don’t like to take on this kind of risk.

Consequently, BDCs get more favorable terms, loaning money for a three- to seven-year term at 12% to 14%, while still getting a senior-position lien on company assets. Yields have been well above 8% on most BDCs.

Using covered calls, you can buy positions in BDCs, then sell those calls to generate more income. Ideally, you don’t sell those calls in the months where the BDCs pay out their dividend, although many of them make monthly distributions. In that case, options expiration dates need to fall prior to dividend record dates by at least three days to account for settlement.

Triangle Capital (NASDAQ:TCAP[1]) has a nicely diversified portfolio of companies and pays an 8.2% dividend. The stock is at $24.70, and the December 25 Calls are going for around 70 cents. That’s a 3% yield on top of the dividend.

TICC Capital (NASDAQ:TICC[2]) trades at $9.82. The December 10 Calls are going for between 20 cents and 25 cents, adding an annualized yield of as much as 24% on top of its very generous 11.4% yield.

Apollo Investment (NASDAQ:AINV[3]) may be one of the most well-known operators, and it’s paying a 10% yield. The stock trades at $7.82, but it has strike prices in one dollar increments. So you can sell the December 8 Call for 15 cents, which is almost 2%. The low stock price and small premium also allows you to save commissions by buying and trading the options in bulk.

Lawrence Meyers does not own shares in any company mentioned.

  1. TCAP:
  2. TICC:
  3. AINV:

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