How to Turbo Charge Dividend Income with Call Options
There are a lot of bloggers in the personal finance realm who are passionate about passive income and dividends. This post is primarily directed at them but also to anyone else who might be looking toward investing in stocks in the future. Take this information and tuck it away. It may be very valuable someday and help you achieve your passive income goals much more quickly.
Learning With an Example
For those who may not be especially familiar with options, I always find it more instructive to use a real life example. The numbers that I am using are from July 13th, 2011.
One of the stocks that I have read about repeatedly on the dividend blogs is Intel (INTC) so I will use that stock as an example. When I look at the price of INTC, I find that I could purchase 1000 shares for $22.60 per share which would cost $22,600 plus some nominal commission using an online broker.
Now most dividend investors would be content to earn a 3.7% dividend yield on this stock. There is nothing wrong with that by any means. But what if I told you it were possible to nearly triple that return? Would you be interested? Let me share how that could work.
When I look at INTC stock over the past 3 years, I find that it really hasn’t traded above $25 per share. It was much lower than its current price in early 2009 in the midst of the financial crisis, but I think it would be safe to say that it is unlikely to trade above $25 unless we see a huge rally. Even with the DOW at record prices in 2007, INTC spent little time above $25. The odds are certainly favorable that $25 is major resistance. Personally I would be happy to sell at $25 netting almost 10% profit.
Selling Covered Calls
Because I am happy to sell at $25, I am willing to sell a covered call with a strike price of $25 per share. Since each contract covers 100 shares, I could sell 10 contracts expiring in January 2012 for 67 cents per share. So what have I done?
First, I have collected $670 premium for selling the call options. I get to keep that money no matter what happens to the stock between now and January. If it remains below $25, then I keep the premium and the stock.
In January when the contract expires my obligation ends, and I can sell another call against my Intel stock. I still get the dividends which would be 36 cents per share plus an additional 67 cents per share making my yield $1.03 on a $22.60 investment or 4.5% for 6 months or 9% annualized. That is nearly triple the dividend yield.
Should INTC trade above $25, I could have my stock called away from me. Then I would have the 67 cents premium, the capital gains of $2.40, plus whatever quarterly dividends got paid out before the increase in stock price. That’s a minimum of $3.07 profit on the $22.60 investment for a six month (or less) return of 13.5%. I’m not going to complain about that.
Afraid Stock Might Rally
If you are afraid the stock might rally, then only sell calls on half the position or 500 shares. The others can freely participate. I do this frequently in my retirement account with some of the more volatile stocks. You can even get somewhat creative and sell some calls that expire in October and some in January. The are many possibilities.
So what do you think? I would love to hear your comments below. Don’t know enough about options? I am working on a site that will be a complete tutorial at Options Dude A to Z. I would love to share what I have learned over the years and my own personal experiences.