For years, I have employed a simple, low risk investment technique called “Covered Calls” that earns an above-average returns. I will try to explain it in a short article but I will strongly recommend more study on the subject before employing this.
I am writing this article with the following parameters in mind for investors who might be interested in doing this on their own:
1.Own or plan to own a self directed portfolio of stocks.
2.Hold or plan to hold a conservative, income-earning portfolio of solid companies.
3.Have a basic knowledge of buying and selling stocks and options.
While the basic technique is fairly simple, there are many advanced techniques which can be utilized to increase income returns but are not only more complex, also have an associated increase of risk. What I will present in this blog article is the basic technique which practically everyone can utilize and increase returns on a dividend-paying stock from 2-3%/year to 10-15% annually with no added downside risk at all.
In this article, I will use the example of holding one stock, Exxon Mobil, the world’s largest oil company. It’s a nice big stable company that is a sound holding in any conservative portfolio, We will pretend we own 1000 shares, which is worth about $100,000 so it’s easy to adjust the numbers to suit your portfolio, ie for $10,000, just divide by 10 or for $200,000, just multiply by 2 and so on.
Ok, so you hold Exxon, which pays a 2.7% annual dividend. As a result, you will have an income of $2700/year or $225/month from your investment in that company. We will now show you how to increase that monthly income substantially with no added risk. (I don’t know the answer yet as I will work it through with you as I write this article).
First of all, what is a Covered Call? Basically, there are people out there who will offer to pay you money for the option to buy your 1000 shares of Exxon. They will do that weekly, monthly, or even ‘way off in the future. For this article, we will focus on the offers to pay you for the option to buy your 1000 shares one month from now.
As of Friday, August 23rd, 2014, speculative option traders will pay you, in cash, at least $1.02 per share for the right to buy your stock at a price of $99.00. The price is currently $98.50. So you decide you will take their offer and you sell 10 “call option” contracts, each contract giving the speculator the right but not the obligation to buy 100 of your shares of Exxon at $99 each. So you decide to do it and here is what happens:
You sell call options for 1000 shares at $1.02/share = $1020.00 cash in your account. No questions asked. So what happens next? There are two scenarios:
- Exxon stock price stays lower than $99 between now and September 20th and the contract expires, allowing you to sell another contract for around $1000 next month, and every month after that.
- Exxon price rises above $99 and the option speculator buys your stock for $99. So, you still keep your $1020, plus you earned another $.50/share because the price rose from $98.50 to $99 so you make another $500. At that point, you can buy the Exxon stock again and sell another covered call, or you can find another stock to buy and sell a call on.
So here is how the returns shape up. If you earn an additional $1020/month on Exxon by selling covered calls, then your return of $225/month for dividends now rises to $1245/month. On a stock you were earning 2.7%/year on, you are now earning 15.2% on!
What’s the catch? There is none except that in order to do this, you should get more informed on this technique by reading as many articles as possible, perhaps a book or two from Amazon. There is plenty of information out there on this and there are some details that you should know to make sound decisions. For instance, some covered call on stocks will give you very tempting returns of 4%/month, but they do so because they are volatile stocks and your stock price could plummet on you overnight, making your 4% profit look pretty small beside a drop of 20% in the stock price. By sticking with known, solid companies though, you can enhance your dividend income significantly without being a genius stock guru.