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Often, after spectacular bull runs of 15.5%, such as we've experienced from November 15, 2012 till now, the markets will go into a consolidation phase. Some investors will want to cash in and take big profits; other investors who have been sitting on the sidelines waiting for a pull-back, finally hop off the fence and join the party.

This push-pull action can lead to several months of sideways to slightly down movement in the markets. This type of consolidation, where the markets simply mark time for a while, can be a great time to enhance returns on a dividend portfolio by selling covered calls.

For a small investment the buyer of the call option receives the right to buy the stock at a pre-determined price before expiration, at some time in the future.

The seller collects a premium from the buyer for granting the buyer this option.

Selling call options on stock you already own is a safe, conservative method, employed to generate higher income and returns on the portfolio you already own.

If you do not already own such stocks, you can initiate Buy-Writes, simultaneously buying a stock and selling the calls, all in one step.

Employing real estate investment trusts (REITs) in this strategy, many already having good dividend yields, is an excellent way to super-charge annualized returns.

Using Friday, March 29, 2013 closing prices, let's look at some possible scenarios, selling slightly out of the money calls.

American Capital Agency Corp. (AGNC)

Current price $32.78

Sell Sept. 33 Call for 75 cents, asked price.

If AGNC rises above $33, anytime before expiration, the buyer of the call can exercise his option and buy the stock from you (call the stock away).

At expiration, if exercised at $33, you receive 22 cents capital appreciation plus 75 cents for the call=97 cents, or .97/32.78=3% divided by 5 months to expiration=.6%x12 months, which annualizes to a 7.2% annual enhanced return. In addition to the 15.25% dividend yield this strategy would total a 22.45% annualized return.

Ticker

Price

Dividend

Yield

Call Premium

Cap. Apprec.

AGNC

$32.78

$5.00

15.25%

$0.75

$0.22

With Enhancement:

Annual

Dividend

Annualized

enhanced

Yield

Return

return

7.20%

15.25%

22.45%

If the price of AGNC is below $33 at expiration, the buyer will not exercise his option to buy the stock from you. You will be left holding your original stock.

If not exercised, the annualized return is the 75 cents call premium/$32.78=2.29%/5 months=.457%X12 months=5.49% annualized enhanced return. In addition to the 15.25% dividend yield your annualized return equals 20.74% in this instance.

Annaly Capital Management, Inc. (NLY)

Current price=$15.89

Sell Oct. 16 Call for 47 cents asked price

At expiration, if exercised, receive 11 cents capital appreciation plus 47 cents for the call=58 cents, or .58/15.89=3.65%, divided by 6 months to expiration=.61%x12 months, annualized=7.3% annual enhanced return.

In addition to the 11.33% dividend yield this computes to an 18.63% annualized return.

Ticker

Price

Dividend

Yield

Call Premium

Cap. Apprec.

NLY

$15.89

$1.80

11.33%

$0.47

$0.11

With Enhancement:

Annual

Dividend

Annualized

enhanced

Yield

Return

return

7.30%

11.33%

18.63%

If not exercised, the annualized return is 47 cents for the call premium/$15.89=2.96%/6 months=.49%X12 months=5.92% annualized enhanced return.

In addition to the 11.33% dividend yield this now equals a 17.25% annualized return.

Hatteras Financial Corp (HTS)

Current price=$27.43

Sell August 28 call for 50 cents asked price

At expiration, if exercised, receive 57 cents capital appreciation plus 50 cents for call premium= $1.07 or $1.07/27.43=3.9%, divided by 4 months=1.56%x12 months=18.72% annualized enhanced return in addition to the 10.2% dividend yield=28.72% annualized return.

Ticker

Price

Dividend

Yield

Call Premium

Cap. Apprec.

HTS

$27.43

$2.80

10.20%

$0.50

$0.57

With Enhancement:

Annual

Dividend

Annualized

enhanced

Yield

Return

return

18.72%

10.20%

28.72%

If not exercised, your annualized return is the 50 cents call premium/$27.43=1.823%/4 months=.46%x12 months=5.52% annualized enhanced return.

In addition to the 10.2% dividend yield, the total return annualizes to 15.72%.

Risks

The major risks inherent to this strategy are two-fold; if the exercise price is not reached by the expiration date of the contract, you, the seller, will maintain ownership of your shares and will not receive the capital gain portion discussed above. This will slightly reduce the annualized return of this strategy. On the other hand, since you retain ownership of the stock, you can simply sell calls once again and reap extra income as you receive the additional call premiums. In other words, rinse and repeat as often as desired and compound your returns.

The other risk, of course, is that any time before or at expiration, the price of the stock may rise above the strike price and be called away from you. If this occurs, you will no longer own the stock, but your annualized return will be enhanced even further. The sooner the stock is taken from you, the sooner you get to book not only the premium you already collected, but also the capital gain.

Time is money, so the faster you receive this capital gain, the higher annualized return you will have received on the money you invested.

In this instance, the investor will now have the opportunity to take all proceeds from this trade, including the original amount invested, the capital gain, the call premium collected, and all dividends received, and reinvest into another security that presents similar characteristics and sell calls again to enhance annualized returns.

Conclusion

Writing covered calls is a method that can safely enhance income in a portfolio. Tying this strategy to a dividend growth portfolio and coupling it with high dividend yielders such as REITs can super inflate returns by 50%-65%. In a sideways market that may ensue after a huge bounce that we have experienced over the past 4 ½ months, this strategy can garner extra income while waiting for the bull to resume and pump up portfolio capital gains.

Source: Super Charge These High Dividend REITs: Write Covered Calls