Generating a consistent cash flow from stock dividends is an appealing benefit from owning shares for many investors. Stock ownership, in these scenarios, can create two income streams, one from price appreciation and the other from quarterly dividends. However, not all securities have associated dividends and some investors will bypass these stocks even if they are quality securities which represent potential impressive returns. Enter covered call writing. By selling call options against shares we hold in our portfolios, we can take a non-dividend bearing stock and create our own “dividends”
Dividends and our Blue Chip Report of Top-Performing Dow 30 Stocks
The brown-highlighted column reflects the annualized dividend yield of the top-performing Dow 30 stocks prior to the July 2018 option contracts. The 10 securities listed in the report averaged an annualized dividend yield of 1.73%. The stock closest to this average is Microsoft Corporation (NASDAQ: MSFT) which had a dividend yield of 1.65%. Let’s see how much a call option would yield in the 24-day period from July 24th through contract expiration on August 17th:
Microsoft option chain for August 2018 expirations
Let’s say MSFT did not yield this 1.65% annualized dividend and we wanted covered calls to create this yield using a practical, efficient methodology. Let’s round off our goal to 2% annually. If we were to write 4 quarterly covered calls, our goals would be to generate 0.50% per quarter. With MSFT trading at $107.46, we know 1% would be about $1.07 so 1/2 of 1% would be about $0.54. The bid column (B) of the option chain shows a price of $0.54 for the out-of-the-money $111.00 call. We follow this procedure 4 times a year and lo-and-behold, we have created a second dividend. In addition to this 0.50% profit, MSFT has the opportunity to rise in price from $107.46 up to the $111.00 strike, another 3.3% of potential share appreciation.
Earnings report risk
The main concern relating to this strategy is when a stock moves well above the strike sold and not allowing us to take full advantage of this share appreciation. The most likely time this may occur is when there is a favorable earnings release. To circumvent this risk, we will never select a contract period that encompasses and earnings report. We should also master our position management skills whenever option-selling is used.
Ex-Dividend date risk and early exercise
The most likely time for early exercise is the day prior to the ex-dividend date. We should avoid these dates as well.
Stocks without dividends: Micron Technology, Inc. (NASDAQ: MU)
MU was an eligible stock on our premium stock report for the August 2018 contracts and did not have an upcoming earnings report prior to contract expiration. The stock was trading at $53.72 on July 24th and so we will target a 24-day return of $0.27 to align with our 2% annualized goal for this “dividend replacement” Let’s have a look at the option chain on July 24th:
The $55.50 strike would be most appropriate as the premium generated would result in a 0.58%, annualizing to 2.3%.
Covered call writing can be crafted to meet various trading styles and meet a wide range of personal risk tolerances. For investors who value dividends, covered call writing is a wonderful approach to either creating dividends that don’t exist or enhance stock returns that already generate dividends.
New Blue Chip Report
The latest Blue Chip Report of the best-performing Dow 30 stocks is now available on the premium member site. One stock was eliminated and three were added since last month’s edition.
February 7th – 10th, 2019
Orlando Money Show
Omni Orlando Resort @ Champions Gate
February 7th – 10th 2019
1. Getting Started with Stock Options: Creating Monthly Cash Flow with Covered Call Writing
February 8, 2019, 3:10 pm – 3:40 pm
2. Getting Started with Stock Options: How to Select the Best Options in Bull and Bear markets
February 9, 2019, 2:00 pm – 2:45 pm
New seminar just added
Charlotte North Carolina:
September 14, 2019
9:30 AM – 12 PM
Your generous testimonials (new feature)
Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:
Reading your book Encyclopedia for Covered Call Writing. I have been selling call options for several years with acceptable results. Your book has given me new perspective and will most likely double my yield. Thank you very much.
This week’s economic news of importance:
- Producer price index Dec. -0.2% (-0.1% expected)
- Home builders’ index Jan. 58 (56 last)
- Weekly jobless claims 1/12 213,000 (220,000 expected)
- Philly Fed index Jan. 17.0 (9.1 last)
- Industrial production Dec. 0.3% (as expected)
- Consumer sentiment index Jan. 90.7 (97.5 expected)
THE WEEK AHEAD
Mon Jan. 21st
- None scheduled
Tue Jan. 22nd
- Existing home sales Dec.
- None scheduled
Thu Jan. 24th
- Weekly jobless claims 1/19
- Markit manufacturing PMI Jan.
- Markit services PMI Jan.
- Leading economic indicators
Fri Jan. 25h
- Durable goods orders Dec.
- New home sales Dec.
For the week, the S&P 500 moved up 2.54% for a year-to-date return of 6.54%
IBD: Market in confirmed uptrend
GMI: 2/6- Bearish signal since market close of November 13th, 2018 as of 1/17
BCI: With volatility (VIX) under 20, I am taking a more aggressive stance and favoring out-of-the-money strikes 3-to-2 compared to in-the-money strikes.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to an improving market tone. In the past six months, the S&P 500 down 5% while the VIX (17.80) moved up by 38%. We can’t forget that the VIX was more than double the current rating on December 24th (36.07).
Wishing you the best in investing,
Alan and the BCI team