By: Costas Bocelli — November 19, 2020
Here’s One Simple Move to Turbo Charge Your Dividend-Paying Stocks
If you’re an investor in search of income, then you know it’s getting harder and harder to find safe, reliable, and relatively high yields.
That’s because global central banks have declared war on income investors and savers.
And make no mistake about it, the pool of higher yielding investments is drying up.
According to the Financial Times, global negative-yielding debt has swollen to record size.
There’s more than $17 trillion in global debt that carry negative current yields.
That means buyers of these bonds that are held to maturity will not only be robbed of an income stream, but also robbed of a portion of their capital investment.
That’s an insane proposition from our perspective.
The enablers of all of this are the global central bankers, or banksters, as we like to call them.
These monetary institutions have driven interest rates down so much that sovereign governments can issue debt to the public that carries negative yields.
The Royal Bank of Australia recently slashed interest rates to 0.10%, a record low. The RBA also announced that it will begin to buy government bonds and join in on the quantitative easing parade.
The Bank of England also upped its bond purchases by another 150 billion pounds, to 895 billion pounds annually.
Then there is the Bank of Japan which recently increased its purchases of Japanese Government Bonds.
And let’s not forget about the US Federal Reserve, which is committed to zero interest rates forever, and to adding $120 billion a month to a balance sheet that's ballooned to more than $7 trillion.
What’s an income investor to do?
For one thing, steer clear of sovereign debt.
Instead, look to U.S. Equities. It’s not only the strongest broad asset class, but a universe that's loaded with dividend-paying stocks that generate returns superior to what you'll earn with traditional fixed-income securities, such as government bonds.
Within the S&P 1500 (large-cap, mid-cap and small-cap), there are more than 500 stocks that distribute dividends of 2% or more annually.
In my October 15th, 2020 column, I shared a nifty income generating strategy that allows you to receive steady and reliable income roughly every 30 days.
We dubbed it the “Paycheck of the Month Club”.
The strategy involves buying at least three high-yielding, quarterly-dividend paying stocks with the disbursement dates spread out in a way that ensures you a dividend payment each and every month.
The key is to identify an early-cycle, mid-cycle, and late-cycle dividend payer.
If you recall, we shared three high-yielding dividend stocks from each of the three cycles:
- Patterson Cos. (PDCO) – Early-cycle
- Chemours Co. (CC) – Mid-cycle
- Garmin Ltd. (GRMN) – Late-cycle
Each of these stocks possessed strong traits of technical strength. And they continue to do so today.
Because even though the primary goal is to generate income, we’re still interested in protecting the value of the underlying asset.
Focusing on technically strong stocks in a long-term positive trend increases the odds that demand will continue to bolster the stock price and provide potential for capital appreciation.
After all, what’s the point of earning a decent dividend yield if the asset drops in value by 15% or more?
I promised in that previous column that I’d share with you one simple, but highly effective technique that can considerably boost your income if you use this dividend-investing strategy.
How to Turbo Charge Your Dividend-Paying Stocks
It’s an options technique called an "over write".
Essentially, it entails selling covered Call options against dividend paying stocks that you own. And if you do it properly, it can significantly enhance your returns by generating additional income.
But before we get into the details, there are several things to consider before applying the strategy:
It’s generally considered a bullish strategy. It works best on securities that are in a long-term positive trend on their price charts.
But it also works well on securities that are moving in a sideways pattern, or not really trending in either direction. Remember, the goal here is to generate income on the asset, so the dividend distributions and the premiums collected from the option sales should do most of the heavy lifting.
The Call options that are to be targeted for sale should be out-of-the-money. That means that investors should look to sell Call options with strike prices that are higher than the current market price of the stock. Look to target the Call option that has a 25 Delta or less.
(Delta measures the price sensitivity of the option. But Delta also gives us the statistical probability, expressed as a percentage, that the option will be in-the-money at expiration. So if our goal is to generate more income with less chance of having the stock called away, focus on the Call options with a Delta of 25 or less.)
This option will provide additional capital appreciation should the stock happen to rise more than anticipated. You see, with a Call option, any upside gains above the strike price belong to the buyer. An out-of-the-money option ensures you’ll be adequately compensated in the event the stock is “called away”.
Also, Call options have a limited shelf life and tend to decay most quickly within the last 90 days of the contract date. And since this strategy entails selling option premium, the erosion of the premium in the option benefits the seller (us).
That said, focus on selling Call options that are 30 to 90 days away from expiration and have a Delta of 25% or less.
That’s the sweet spot for turbo-charging your dividend-paying stocks.
If this technique can be applied four times or more over a one-year period, you’ll get to collect even more paychecks from your dividend paying stocks.
One check will be paid by the company (dividend distribution) and the other by the options market (from the sale of the Call option).
Let’s use Garmin Ltd. (GRMN), our late-cycle dividend payer, as an example of how to apply the turbo-charging technique.
And let’s say that we own 200 shares of stock.
If you recall the article from a month ago, the ex-dividend date for the next distribution is December 14th. So to receive that payment, you’d need to own or buy the stock before December 14th. If you do, then you’ll be entitled to the $0.61 per share payment that will be paid on December 31st.
And since we own or plan to buy into a 200 share position, we would expect to receive a $122 dividend payment.
At the recent share price of $115, the stock is currently yielding 2.1% annually.
Not too shabby…
But if we want to turbo charge those returns, we could look to sell two out-of-the-money Call options and generate even more income.
You could look to sell the GRMN January (2021) 125 strike Call for $0.95.
And since we own 200 shares, we can sell two Call option contracts and collect another $190 in income.
The Call option is 15 points out-of-the-money and has a Delta of 18. So there’s only an 18% chance that the stock will be above $125 at January expiration or 57 days from now.
And should the stock be above $125 at that time, it would represent a 13% gain in capital appreciation. So in that event, you’d be well compensated.
By selling two call options and collecting another $190, you boost your annualized return.
With 57 days until expiration, the Call option sale generated a 5.3% annualized return. That pairs nicely with the dividend, wouldn’t you say…
Got options? You should!