This ongoing series hopefully has been helpful to many individual investors who are seeking not only more income and a more secure financial future, but also to those who are just now building a portfolio and are seeking as much of an education as possible.
By using our BTDP as our featured portfolio right now, I have been offering suggestions as to how to manage and build a portfolio to produce income.
The other day I showed a simple approach to expanding our portfolio (which I have done) to include some dividend opportunities, to pump up income without spending more money. Today I will take this opportunity to briefly explain, in plain English of course, how I have gone about adding a few more dollars to my annual income without even adding one single share.
Here Are The Stocks We Are Working With
The newly updated and re-balanced BTDP consists of the following stocks: AT&T (NYSE:T), Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), Coca-Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Altria (NYSE:MO), McDonald's (NYSE:MCD), Chevron (NYSE:CVX), Apple (NASDAQ:AAPL) General Electric (NYSE:GE), Ford (NYSE:F), Microsoft (NASDAQ:MSFT), Wal-Mart (NYSE:WMT) and Pfizer (NYSE:PFE), Annaly Capital (NYSE:NLY), American Capital (NASDAQ:AGNC), and BGC Partners (NASDAQ:BGCP).
These are the sales we made recently:
The figure on the right is the amount of income I deducted from the portfolio.
These are the purchases I made:
The figure on the right is the income I added to the portfolio.
Here is the complete updated portfolio with all the information I need for this article:
|52 wk lo||52 wk hi||TGT PRICE||Symbol||Shares||Orig.Yield||Dividend||Yrly Income||Share Price||Tot.Cost||Tot. Value||30-Jun||Tgt Price||% To Sell||Tgt Price||% To Sell|
As you can see, I have increased the total annual income with a few simple moves and my yield on cost (which is secondary by the way) has gone from 3.43% to 4.40%. The income now stands at $4,866, more than $1,000 more annually, and it did not cost me a dime out of pocket aside from a few transaction costs that are minimal these days.
Selling (or writing) Covered Calls Can Supplement Your Income From Time To Time
Let see if I can make this easy.
1) You own 100 shares of XXX
2) You paid $10/share for XXX
3) XXX has options available to trade in
4) You can buy calls (up button) or buy puts (down button
5) you can also SELL calls AGAINST the shares you actually own in the hopes of generating additional income.
Selling covered calls takes a bit more understanding than simply buying or selling options. Obviously you need to own at least 100 shares of a stock. If options are available, you can sell calls against your position at a specific price with a specific expiration date.
Stock XXX has an call option that you can SELL, giving the rights of ownership to someone who is BUYING the calls, to own YOUR shares at a price YOU set.....the options usually have a list of prices (strike prices) that you can select from.
So let's say you like your stock at $10.00/share, but feel you would be willing to give some shares up at 12.50/share in the next 30 days. If the share price rises to 12.50 and you SOLD a covered call, those shares will be taken away from you. Obviously, you would have profited by 25% on the shares, and whatever you "earned" (the premium) by selling the calls.
Good deal right?
If the calls you sold had a premium of .40/share, you would have received that money immediately and could have taken the money along with the proceeds of the stock taken, and either added it to your cash reserves, added more shares of another stock, or one you already own, thereby increasing your dividend income once again, without spending a penny.
No matter what happens to the stock itself, that money is yours. So lets say you love the stock, but it has a lousy month and the share price drops to $8.95.....guess what....you keep the shares, plus you keep the premium from the calls you sold, and your income from dividends remains the same plus you can do the exact same thing.
There are a few "catches" though.
If the stock goes to 20 bucks in the next 30 days, if you do not do something to stop your shares from being taken, you would have missed the run-up from 10.00-20.00....even though you still made money and kept the premium from the calls you sold.
Let me say this....people get really annoyed when this happens because they feel like they missed the boat...OK, true, but it was YOU who decided to sell the calls and WERE happy with a 25% gain when you made the trade right?
Don't be angry or annoyed....you made money. Get over it. You can always buy the stock back when it dips, or on the very next trading day!
Now lets say that the CEO is found to be illegally doing something, the company stinks and the stock dives to 2 bucks a share. If you do NOT do something to change the option strategy, you will NOT be able to dump the shares and you will still own them at the price they are at the expiration of the calls.
Hmmm, yikes your stuck!
No, there are two other ways to play this. If you see that the shares of the stock are moving quickly higher, you can buy the calls back that you sold. It might cost some money but you will ride the upside and can always decide to sell another call option anyway.
If the company tanks and looks like its going bye bye....you can also buy the calls back and THEN you can dump the shares....if you are quick enough, you might be able to salvage more from the share price of the stock, and the cost you pay to buy those options back will be cheap enough to where you will probably make some money on them, after transaction costs. That being said, you are likely to take a hit.
At least, there are ways to reverse the trade to avoid a total wipeout!
Here is what I do: I will only sell a covered call on a stock that will not go up too much or down too much. Like JNJ or another huge blue chip. The mega cap dividend stocks usually do not go up or down THAT much, and if they do, I personally will allow my shares to be taken and buy them back on the very next trading day. If the share price happens to drop, the option I sold expires worthless, and I keep the shares and the premium I made from the options.
There are 100s of different strategies with options, but I do not go near them anymore. For me, if I am going to play the options game I will either buy them sell them, or write (sell) covered calls.
One Other Strategy That Is A Bit Trickier
I have also sold "naked puts" at a price below the current share price of a stock I want to add shares to, or open a brand new position. This is actually the reverse of selling covered calls. The catch here, is that the brokerage will freeze an amount of funds just in case the share price drops to where you will actually own the shares. Once the option expires the cash frozen will be released, or used to pay for the shares at the price you wanted, if the stock is assigned to you.
If the share price does not drop to my level, I still keep the premium on the puts I sold, and once again I can use it to buy shares of something else, or build up my cash reserves. I still have not spent one penny aside from the transaction costs. The only way I would actually spend money with this strategy, is if the share price drops to the price I want to pay for it.
Keep in mind that you really must want the stock you do with this, and I have always done this with those same mega cap blue chip stocks I already own because of the reduced volatility as well as my confidence in the stock.
In order to do this, you do need to have the cash in your account, or a line of credit, or margin. I never use margin and use this strategy very sparingly. The ease of selling covered calls is my own personal preference.
The Bottom Line
If there is anything that you do not understand in this simple primer, do not even bother to get involved. For myself, I have added from 5-15% annually to my income stream, just by selling covered calls.
There are all sorts of information that you can find on the internet to explore these strategies further, but keep in mind the risks that I have already outlined. The entire idea behind this strategy is to give your income a boost every so often, and income is what this is all about.
Disclosure: The author is long AAPL, BGCP, CVX, F, GE, JNJ, KO, MCD, MO, MSFT, NLY, T, XOM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.