What's Better? Dividends Or Covered Calls

Includes: AAPL, INTC, P, WEN
by: SA Editor Rocco Pendola

Last week, I hit the 100-share level in Intel (INTC) and the 400-share marker in Wendy's (WEN). Both stocks pay a dividend. INTC comes in at $0.21 per quarter, while WEN offers a modest $0.02 every three months.

If things stay as they are (INTC's should increase, while WEN's is less stable), I will earn roughly $84 a year on my INTC shares and $32 annually on my WEN shares. Both numbers will move slightly higher for several reasons: I own just over the listed amounts, I continue to add to both positions on a weekly- to bi-weekly basis and dividend reinvestment throughout the course of the year will also help take my totals higher.

Today, I topped the 200-share threshold in Pandora (P). That stock does not pay a dividend, nor do I expect it to or want it to.

It has not taken me very long at all to reach these levels. As long as nothing changes materially in my life or in the stories of these companies I intend to stay the course and amass even larger positions. The ultimate goal here is to realize the rewards that come alongside regularly-scheduled investments in a small stable of stocks, ranging from large-cap dividend-payers, turnaround stories in the making and hyper-growth Internet stocks.

Dividends operate on auto-pilot. As companies and your investments grow, the income you can collect and/or reinvest continues to rise. It's a beautiful thing watching it happen, particularly on larger and more mature positions. While nothing beats the ability to buy more shares on a regular basis, dividend reinvestment does the trick remarkably well.

Covered call income does not run on auto-pilot. It's a very active strategy. It's a strategy that I employ often and would love to use in association with these three positions. I wonder, however, if it makes much sense to start writing covered calls on these stocks until I own more shares.

Transaction costs always matter. While I do not mind the $30-$40 I pay to Sharebuilder each month to build positions (I have yet to find a better deal outside of some DRIPs, when available), the options commissions at almost every reputable retail brokerage are off the charts.

Consider this. The INTC $29 call brings in, as of this writing, $0.25. That does not sound like much, however, if I do that five times in a year, that's an additional $125 and an additional three shares or so of INTC if I reinvest that money. That beats the dividend I stand to collect and helps enhance the power of my position.

Here's the deal, though. If I write that call right now in my Sharebuilder account, the commission totals $8.70. That brings my net covered call income to $16.30. While I would not do this on WEN because I do not want to lose my shares, I could write four WEN April $5 calls and bring in $0.40 total. It would cost me $10.95 to put on the trade, bringing my net income to $29.05. With P, the April $11 call smells pretty to me at the moment. I could write two of them against my shares and take in $0.30, but, after commission, I am left with $20.55.

I keep asking myself if it's worth putting my shares on the line when I am giving so much money to the middleman. Now, let me be clear, I love Sharebuilder. This is not a knock on them. I could transfer these positions to any number of other firms and, at most of them, the commission either trends higher, is the same, or is not low enough to justify the switch, particularly if I intend to continue dollar-cost-averaging, which I do.

I sit at a bit of a crossroads. On INTC, if I could collect $16.30, after commissions, five times a month, that's $81.50. Almost equal to another dividend on 100 shares. That sounds pretty good put that way, but, as always, Seeking Alpha readers help me flesh out my thought process. So, please, be my guest in the comments.

You do not run into quite the same problem with a stock like Apple (AAPL). If I own 100 shares and write the April $650 call, I generate $6.70 in income. I have no qualms whatsoever over giving a brokerage $8.70 out of $670. I would do that all year long, which is why, if I still owned AAPL shares, I would never have asked for a pesky dividend. The covered call income, even after transaction costs, you can write for yourself ends up dwarfing the dividend.

That's not the case with lower-priced stocks. The commission stays the same regardless of the price of the option contract. I am leaning towards writing some calls on INTC and P. Initially, I thought that it's not worth the time and expense, however that's also what some folks think when they buy their first 3.3531 shares of a stock. Covered call income, even after the fees, adds up fast, just like your number of shares, which reinvested covered call income can help jump start.

There's no question in my mind that dividends are better than covered calls, in many, though not all, cases, plus they're free ... but wait ... I forgot about taxes. I think I will wait until after April 15th (or whatever it is this year) before I factor that headache into the equation.

Disclosure: I am long INTC, P, WEN.