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Cliff Wachtel, CPA, is currently the Director of Market Research, New Media and Training for, a fast growing forex and CFD broker. He covers a variety of topics including global market drivers, forex, currency hedged and diversified income investing, and is currently working on a... More
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    For Lower Risk AND Higher Yield


    1. Introduction

    For dividend income investors not familiar with options, here are some simple, ideas you should consider for getting higher yields with little or no additional risk.


    This article is intended purely to introduce some simple, conservative options strategies for both decreasing risk and increasing income. Dividend investors who are often unfamiliar with options, can then decide if these are worth further investigation. Readers will need to do more homework before implementing these strategies, and stay tuned for follow up articles in this blog or in my newsletter, The High Dividend Stock Guide. See below for some additional resources.


    A. Options Need Not Be Risky or Complex

    Most dividend income investors tend to be risk averse and prefer the simplicity of buying and holding quality stocks with reliable yields. For most dividend investors, the very word “options” connotes high risk and complexity.


    In fact, there are options strategies that are simple, and can increase your annual yield with little or no additional risk.  The level of risk and complexity varies completely with how you use options. It's like comparing auto racing to conservative driving. Both can be called driving, however the risk and skill levels demanded by the two activities differ dramatically. The same goes for options trading.


    Again, used properly, stock options can actually reduce risk and increase your income.




    B.  Why Dividend Investors Should Consider Options

    How would you like to make an additional 5%-10% or more annual yield on stocks you already own, and plan on holding? It’s possible by selling Covered Call options, which are just rights to buy your stock.


    Are there stocks you would love to buy if they drop to a certain lower price? Rather than simply placing a buy order at that price, you can sell a put option, which is a contract to buy someone’s shares if they sink to a certain price. Your put option buyer gets insurance against a price decline below that price. You get the stock you’d have bought anyway – at a further discount equal to the put option sale price.


    For overall portfolio insurance against market declines, you can buy put options on a major index or surrogate of an index.  



    C. Basic Concepts

    Here’s the basic vocabulary of stock options.


    1.   Definitions

    An option is short for an options contract, which is a formal agreement providing the right (but not the obligation) to buy or sell a fixed number of 100 shares of a given stock on or by a specific date called the expiration date at a specific price called the strike price. Note that options typically trade in units of 100 shares called contracts. Thus instead of selling options on 300 shares, you’d sell three contracts. So if you trade online, you’d enter ”3” not 300 in the Quantity or Amount field when placing your sell order, otherwise you’ll be selling options on 30,000 shares. Your trading platform will alert you if your portfolio isn’t large enough to cover that, but if it is, you could make an expensive mistake.


    2.   Two basic kinds of options:

    A call option is a right to buy. Visualize calling someone over to give you the shares for which they have sold you the right to buy at a given strike price and by a given expiration date.


    There are two kinds of call options. Covered calls are rights to buy stock that the seller already owns, so he is "covered" against the risk of needing to buy shares that have suddenly risen in price in order to fulfill his obligation to the buyer of the call option on the expiration date. 


    FYI, selling naked calls means selling calls on shares the seller does not currently own, and who risks being forced to buy shares that have unexpectedly risen in order to fulfill his obligation, just like any short seller. This strategy IS obviously more risky and beginners should avoid it.



    A put option is the right to sell. Visualize your putting the shares into a buyer's hands.



    3.   The Price of an Option is Composed of Two Parts


    Intrinsic value:  Is simply the REAL value of the option if exercised at a given moment. If a stock sells for $10/share, an option to buy the stock for $5/share (i.e. a call option with a $5 strike price) is worth about $5/share, or $500/contract, since the owner could exercise the option and save that amount.


    Only options that are in-the-money have intrinsic value.


    That is, a call option (right to buy or call in) has intrinsic value only to the extent that its strike price is BELOW the market price, because it gives the owner the right to buy the stock below market value.  


    A put option (right to sell or put into the put option seller’s hands) has intrinsic value to the extent that its strike price is ABOVE the stock price, because it allows the owner to sell the stock above market value.


    Time value: The value of the time left to exercise the option. An option is a right for a specified time. The more time left on the option for the price go in the owner’s favor, the more time value and the higher the option price.  


    4.   In General, Sell Options, Don’t Buy Options


    Thus time works in favor of option sellers, and against option buyers. An option buyer must not only be right about the direction of the market (hard enough), but the timing as well, because the option becomes worthless after the expiration date. Thus the time value portion of the option is always dropping.


    Unless you’re buying puts (rights to sell) as insurance, option buying is a riskier strategy better suited to those with more trading skills and/or risk tolerance than the typical income oriented investor.


    In general, conservative income investors stick to selling options, except for buying index puts as portfolio insurance


    Sell covered calls to enhance yield on stocks you own.


    Sell puts in order to buy stocks you would buy at the strike price anyway in order to get them for even less, thus enhancing yield AND reducing risk of loss with a lower cost basis.



    Below we will provide a brief introduction or review of some of the most basic options strategies for enhancing yield, reducing risk, or both.


    2. Selling Covered Calls


    Did you know that it’s very possible to earn an extra 5%-10% annual yield (or more) on stocks you already own? You could do it by selling a call option (an option to buy from you) on those shares at a price that’s a bit higher than the current price. Because you already own the shares, this call option is called a covered call. In other words, you’re covered against the risk of needing to buy the shares at a price above your strike price.


    A. Advantages

    If you plan on holding the shares, there is no additional risk, because you’ve already assumed the risk of stock ownership.


    There are only two possible outcomes, both of which are better than simply holding your shares.


    ·   &nbs... If, on the expiration date of the call option, the stock price rises above the price you specified, the strike price, your stock gets called, or sold at the strike price. You’ve lost nothing except the potential gain above the strike price. Again, if you planned on holding the stock, you wouldn’t have gotten that anyway.


    ·   &nbs... If the stock is below the strike price at the expiration date, the covered call option expires. You keep the stock and the sale price or premium.


    In either case, you pocket the extra cash from selling the covered call option.


    Obviously, we want to sell covered calls at a strike price above our cost basis, so we still profit if the market price is above the strike price and the shares are called. Ideally we’d like to sell at a strike price above where we believe the price will rise by the expiration date, so that we can keep both the premium and the shares.


    B.  The Tricky Parts


    Timing: The hard part is in the timing. The more the options are out-of-the-money, i.e. the more the strike price is above the market price, the lower the value and price of the option, since the buyer has a higher risk of the option expiring worthless.


    So covered call sellers ideally try to sell calls at market peaks. Few are good at market timing.


    Option Price Increments: Unlike stocks, options are not sold in penny increments, rather at increments of between $2.50 and $5.00 or more, depending on how high the stock price. Thus you can’t always trade options at prices that will cover your cost basis AND give you a decent return.



    C. Disadvantages


    When you sell covered call, you risk missing at least some of an unanticipated rise in the stock price. If your strike price was below your cost basis in the stock plus the cash from the option sale, you risk a loss either from selling the stock at a loss or buying back the call for more than you sold it.


    3. Selling Put Options on Stocks You Want to Own



    Is there a stock you’d like to buy once it gets down to a certain lower price? How would you like the chance to buy at that low price, with an additional discount? You could do it by selling a put option (option to sell to you) on that stock at that desired strike price.


    A. Advantages


    There are two possible outcomes, both of which are better than simply putting in a buy order at the given price.


    ·   &nbs... If, on the expiration date of the put option, the stock price is at or below the specified strike price, you pay for the stock at the price you wanted, with an additional discount in the form of the premium you were paid up front when you sold the option.


    ·   &nbs... If on the expiration date of the put option the stock is above the strike price, the buyer does not sell to you. You got paid for providing insurance to the buyer of the put option against a price drop below the strike price.


    Again, in either case, you keep the premium from the sale of the option.


    B.  The Tricky Parts


    Obviously, we want to sell covered calls at a strike price at or near strong support, at what we consider bargain levels. Ideally we’d like to sell at a strike price below where we believe the price is likely to drop by the expiration date, so that we can keep both the premium and the shares.


    As with selling covered calls, the tricky part is in the timing. The more the options are out-of-the-money, i.e. the more the strike price is below the market price, the lower the value and selling price of the option, since the buyer bears greater risk of the option expiring worthless.


    So put sellers ideally try to sell at market bottoms. Few are good at market timing.


    Option Price Increments: Unlike stocks, options are not sold in penny increments, rather at increments of between $2.50 and $5.00 or more, depending on how high the stock price. Thus you can’t always sell put options at strike prices that are low enough to want to buy the stock, AND to get a good premium on the sale of the put.  


    A. Disadvantages


    When you sell a put, you risk “catching a falling knife,” that is, being obligated to buy a stock after its price has plummeted, and you wind up taking a loss either from buying a stock well above its market value or buying back the option for more than you sold it.




    4. Buying Put Options on Stock Indexes or Their Surrogates for Overall Portfolio Insurance


    Even an introduction to this strategy requires its own article, since this strategy can get complicated. For now, know that you want to take a certain portion of your dividend yield and use it to buy put options on an index or surrogate for one. For example, if you own a general portfolio, puts on the S&P 500 index or SPYs would work. Those heavy in energy would seek to dedicate a portion of their dividends to buy puts on something tracking energy. The idea is to get some insurance without gutting your returns. More on this at a later time.



    5. Options are Not Always Available




    You may not be able to trade options on thinly traded and/or foreign shares, especially if you only trade on U.S. exchanges. Fortunately many of our recommendations do have options, including most of the more liquid foreign ones.


    BP, plc (NYSE:BP), CNOOC Ltd. (NYSE:CEO), Enid SpA (NYSE:E), Total Fina Elf (NYSE:TOT), Veolia Environmental SA (NYSE:VE), AT &T Inc (NYSE:T), Verizon (NYSE:VZ), Otelco (OTT), Windstream Corp (NASDAQ:WIN), Buckeye Partners (NYSE:BPL), El Paso Pipeline Partners (NYSE:EPB), Enterprise Products Partners (NYSE:EPD), Energy Transfer Partners (NYSE:ETP), Kinder Morgan Energy Partners (NYSE:KMP), Magellan Midstream Partners (NYSE:MMP), Nustar Energy (NYSE:NS), ONEOK Partners (NYSE:OKS), Sunoco Logistics Partners (NYSE:SXL), TEPPCO Partners (TPP), Tortoise Energy Infrastructure Partners (NYSE:TYG), Alliance Resource Partners (NASDAQ:ARLP), Northern Resource Partners (NYSE:NRP), Penn Virginia Resources Partners (NYSE:PVR), Terra Nitrogen Company, L.P. (NYSE:TNH), StoneMor Partners (NYSE:STON) Dominion Resources Inc. (NYSE:D), Duke Energy Corp (NYSE:DUK), Progress Energy (NYSE:PGN), Southern Company (NYSE:SO)





    6. Sources for Further Study


    If the above strategies sound intriguing, you'll need to do more homework. Here are a few free sources for getting started.


    A. Free Online Resources


    Any internet search using various combinations of terms as

    ·   &nbs... "stock options" AND (introduction OR guide OR beginner)

    ·   &nbs... "options" AND  "investing

    ·   &nbs... "options strategies" AND stocks


    will provide you with numerous well written, more detailed introductions to the topic. A few sites to browse for introductions to options and terminology include:


    ·   &nbs...

    ·   &nbs... http://www.investopedi...

    ·   &nbs...  (for ordering the books mentioned below and further materials for implementing his strategies)


    B.  Books



    There are many. Here are a few suggestions that would be an excellent start for high dividend and others who invest in stocks for dividend income.


    Show Me the Money: Covered Calls & Naked Puts for a Monthly Cash Income by Ron Groenke, Keller Publishing, 2004: (Order via  or other online sellers). I actually read an earlier version called Covered Calls and Naked Puts, this is an updated version.


    This book is one of the most mercifully clear, jargon-free and concise introductions to simple options strategies for income, yet at the same time provides fairly detailed explanations of how to implement the strategies discussed. Written as the story of a retiree who reunites with his old college Finance Professor in a Florida retirement community, the author explains his techniques through dialogues between the two men. The story slows down the information flow a bit, but many will find the book far easier to read than a typical book on the topic.


    Put Options by Jeffrey M. Cohen, McGraw Hill, 2003. The best book I’ve found on how to use puts for both income reduction and risk. Some new twists on using puts, very worthwhile specifically for conservative, risk averse income investors. Great ideas, clear and well explained.







    7. Conclusion, Disclosure & More Info



    Disclosure: I have positions in most of the above mentioned investments.


    Interested in learning more about investing in stocks that provide reliable high dividends with better transparency, appreciation potential, and liquidity than bonds? Visit http://highdividendsto...








    May 04 5:50 AM | Link | 1 Comment





    Here in Part 11B, the second part of this mid-way review of the series: The High Dividend Investor’s Collapsing Dollar Survival Guide, we briefly review the stocks that help you avoid the Seven Deadly Sins for Income Investors.











    In short, we’re seeking stocks of strong companies that have:


    ·   &nbs... Strong earnings (or in certain cases funds from operations) that can sustain the dividends

    ·   &nbs... High dividend yields

    ·   &nbs... Earn and distribute a high dividend in a non-USD currency and /or has a dominant position in a market for an essential product or service that allows it to pass on US dollar price increases to its customers




    Perhaps the one distinct upside of a world-wide stock market collapse is that prices get so beaten down that the previously modest yields of many blue chip companies suddenly become high, as scared investors demand a higher risk premium. For the best of these, their price declines are not due to deteriorating fundamentals, but mostly due to hedge and mutual funds dumping shares to meet redemption and/or other requirements. The below list is not comprehensive, merely the stocks which I’ve found thus far. Suggestions for additional combination high dividend and U.S. dollar hedge stocks are welcomed.





    A. International  

    Because one of our criteria is that the stock price and distribution must be pegged to a non-USD currency, no surprise that most of the best USD hedge high yield stocks based outside of the U.S.


    1.   Energy

    The return of high oil and gas prices is a matter of when, not if. Some of the best income plays are in energy, and the stock prices and dividends of many have been beaten down along with oil and gas prices.


    Big Integrated Oil: Yes, definite risk of further price and even dividend cuts while oil prices remain low. At the below recommended buy prices, most of that risk is priced in, and far outweighed by the rewards when energy prices resume their long term uptrends.


    ·   &nbs... BP, plc (NYSE:BP): Unique as the only big integrated oil with a large, reasonably safe (barring further deterioration of energy prices. Yield is among the highest of the big oils.


    ·   &nbs... CNOOC Ltd. (NYSE:CEO): A subsidiary of China National Offshore Oil Company, CNOOC is a unique triple combination play on income, China and energy, so I’ll accept the lower dividend. The dividend is only around 5%, and even then only when price is around 87.  Volatile price can move very fast either way along with oil prices, and its yield is lower than we normally accept, so don’t chase this one much above $85. However, likely fast appreciation when oil prices recover makes this stock worthwhile as a combined income / growth play.


    ·   &nbs... Eni  SpA (NYSE:E): This Italian integrated oil can profit on both  production (upstream) and the refining, marketing, and distribution (downstream) side. Expects to grow output around 3% per year, debt manageable.


    2.   Communications


    Cellcom Israel Ltd. (NYSE:CEL): Operating income up, profits up, dividends up, free cash and domestic demand steady despite weakening Israeli economy. Benefiting from growing sales of more advanced phones, which offer more services and revenue opportunities.


    France Telecom (FTE): Expanding into South American Internet market, payout ratio about 90%


    Telefonica (NYSE:TEF): Expanding into Czechoslovakia, still able to get credit as sign of financial strength



    3.   Utilities


    Veolia Environmental SA (NYSE:VE):  It operates in four segments: Water, Environmental Services, Energy Services, and Transportation.


    This French firm one is unique because it’s the only serious dividend in the high potential growth international water sector. A dominant player in a hot sector, price beaten down with the market transforms its formerly modest yield into a generous one.  Struggling with earnings growth like many companies in this environment, it’s a good long term play.    


    One of the largest integrated water infrastructure companies in the world, with solid financials, is a prime beneficiary of the increasing investment in water world-wide, including the U.S. Based in France, it earns all over the world. VE provides solution to every water infrastructure issue, from supply to conservation to wastewater processing and recycling. Steadily rising but modest dividend, combined with a stock price that has fallen harder than the overall market, (from around 90 to about 20), has transformed this formerly modest yield into a generous one close to 10%, based on last May’s 1.89 dividend (it only distributes once a year) though Yahoo! Finance for some reason has it set at about 15%.


    ENEL-SOCIETA PER AZI  (OTCPK:ENLAY):  An Italian utility with interests in Spain as well,  Enel Spa is the short name for Ente Nazionale per l’energia Elettrica - Societa Per Azioni. Price has dropped over 50% over the past year, due mostly to euro weakness, debt used to buy the huge Spanish utility Edsa (OTC: ELEZF), and a dividend heavily cut. Thinly traded on the OTC market. Profits for 2008 were up 45%, debt is declining, and the firm as stated it will maintain its dividend in 2009.   






    B.  Canada

    Due to the abundance of stocks with solid fundamentals, low tax structures, and their CAD denominated prices and very high yields I give “my Canadians” their own category.  The CAD is a prime commodity based currency backed by one of the healthier banking systems. In addition to their share prices being down with the overall market, these carry an extra discount due to the CAD’s recent decline against the USD. They have not expanded money supply as much as the US, and the ultimate recovery in energy will be very bullish for the CAD. Prices quoted are in USD.


    1.   Energy Income Trusts

    All will continue to suffer price and dividend declines along with energy prices, but will soar when they recover, even with the higher taxes from 2011 onward. These are priced so low, (many at the assumption of oil at much lower prices) that the risk is worth the reward. Yields are so high that investors already appear to have priced in further substantial dividend cuts that will still leave us with yields over 9%. Take only partial positions until energy prices appear to have stabilized, but be ready to load up on these as the market begins to show interest.



    Advantage Energy Income Fund(AAV, TSX:AVN.UN)


    ARC Energy Trust (OTC: AETUF, TSX: AET-UN)

    Claymore/SWM Canadian Energy Income Fund (NYSEARCA:ENY): For those that want to buy a basket that attempts to mimic this sector. Unfortunately, many good assets are not widely traded enough for this fund, which is why I prefer to cherry pick individual stocks.


    Enerplus Resources Fund (NYSE:ERF)


    Peyto Energy Trust (OTC: PEYUF, TSX: PEY.UN)


    Provident Energy Trust (PVX, TSX: PVE.UN)


    Vermillion Energy Trust (OTC: VETMF, TSX: VET.UN



    2.   Clean Energy Income Trusts


    Atlantic Power Corporation (OTC: ATPWF, TSX: ATP.UN),


    Energy Savings Income Fund (OTC: ESIUF, TSX: SIF.UN)


    Innergex Power Income Fund (OTC: INRGF, TSX: IEF.UN


    Macquarie Power & Infrastructure (OTC:MCQPF, TSX: MPT.UN


    Great Lakes Hydro  Income Fund (OTC:GLHIF, TSX: GLH.UN


    3.   Energy Infrastructure Income Trusts


    Altagas Income Trust (OTC:ATGFF, TSX: ALA.UN

    InterPipeline (OTC: IPPLF, TSX: IPL.UN)

    Keyera Facilities (OTC: KEYUF, TSX: KEY.UN)

    Pembina Pipeline Fund (OTC:PMBIF, TSX: PIF.UN)

    1.   Utility Income Trusts:


    Bell Aliant (OTC: BLIAF, TSX: BA.UN)



    2.   Healthcare


    CML Healthcare Inc. Fund(OTC:CMHIF, TSX: CLC.UN)



    3.   Real Estate Income Trusts


    Canadian Apartment Properties REIT(OTC: CDPYF, TSX: CAR.UN


    Northern Property REIT (OTC:NPRUF, TSX: NPR.UN)




    4.   Business Trusts


    Yellow Pages Income Fund (OTC:YLWPF, TSX: YLO.UN)



    The second tier consists of U.S. based companies that lack the USD hedge in currency but have strong enough businesses dominating vital commodities or services that should allow pricing power to insulate investors against a declining dollar. It’s also worth repeating that while the dollar is in trouble, it’s hardly assured that it will do worse than most others or that it will lose its primacy.


    1.   Communications

    Yes, communications companies depend on credit markets for their substantial capital spending needed for growth, and thus are sensitive to tight credit. However, the dominant players provide critical services and will have the pricing power to prosper in the long run. Below are two pairs of telecoms that represent two valid ways to play this vital industry for income. Will discuss in detail in coming articles.


    Two Giant Telecoms: The more conservative approach, with solid dividends rarely seen so high for such blue chip firms.


    AT &T Inc (NYSE:T)


    Verizon (NYSE:VZ)



    Two Rural Telecoms: The higher dividend approach, with solid fundamentals to sustain and grow these dividends. Some of the safest 12% plus dividends, plus potential for substantial capital gains as the current fear and risk premium subsides and bids up the share prices.


    Otelco (OTT)  


    Windstream Corp (NASDAQ:WIN)





    2.   Energy Infrastructure MLPs


    To be covered in greater detail in later articles.


    All the below offer yields around 9%, which are backed by prospering businesses with reliable cash flows. Their unit prices fluctuate with the market and hence are bargains because while their stock prices have declined with the market, their revenues and yields have held steady.


    Also, as noted in my earlier articles, Energy Infrastructure MLPs: Among the Very Best High Dividend Stocks and Top 10 Energy Stocks..., many investors have wrongly believed that revenues of these energy distribution and storage companies are directly tied to energy prices. In fact most revenues come from simple volume moved or stored. Thus shares have been unfairly dragged down both by market sentiment and declining energy prices.



    Buckeye Partners (NYSE:BPL):  Raised dividend 6% over the past year.   &nbs...


    Enterprise Products Partners (NYSE:EPD):  Raised dividend 6% over the past year.   &nbs...

    Energy Transfer Partners (NYSE:ETP)


    Kinder Morgan Energy Partners (NYSE:KMP): Raised dividend 14% over the past year.   &nbs...

    Linn Energy Partners (NASDAQ:LINE): Linn posted an adjusted fourth-quarter loss from continuing operations of $435,000, or break-even per share, below the average analyst estimate of earnings of 32 cents a share, as it was hit by a wildfire in its Brea Olinda Field in California and weak production in the Mid-Continent.


    However, the company said production is 100 percent hedged for 2009, 2010 and 2011, and its shares rose 10.7 percent. Linn halved its 2009 capital expenditure

    budgets, joining a long list of exploration and production companies to do so as the sector has been hit hard by the drastic fall in oil and gas prices and the credit crunch.


    Magellan Midstream Partners (NYSE:MMP): Raised dividend 8% over the past year.   &nbs...

    Nustar Energy (NYSE:NS): Raised dividend 7.4% over the past year.   &nbs...


    ONEOK Partners (NYSE:OKS): Raised dividend 5.3% over the past year.For 2009, projecting lower net income between $3.15 and $3.75 for ONEOK Partners about 25 percent less than 2008.   &nbs...

    Sunoco Logistics Partners (NYSE:SXL)

    TEPPCO Partners (TPP)

    Tortoise Energy Infrastructure Partners(TYG) Actually a fund of MLPs.



    3.   Coal MLPs

    In addition to a depressed overall market and energy prices, coal is not an especially clean fuel source and President Obama specifically warned utilities not to build new coal fired plants.  Nonetheless, coal demand is not fading anytime soon, and is more likely to grow due to lack of alternatives and improved environmental technologies, even under the current economic climate. Coal prices and the below stocks will soar as energy recovers, or if events in the Middle East or elsewhere make energy imports more problematic.


    Alliance Resource Partners (ARLP

    Northern Resource Partners (NYSE:NRP)

    Penn Virginia Resources Partners (NYSE:PVR)


    4.   Other Sector MLP

    Terra Nitrogen Company, L.P. (NYSE:TNH): A rare income play on the long term growth in fertilizer demand. Because it only trades a bit over 100,000 shares per day, its price can be very volatile, so don’t chase it much over $100/share in this market. Like any low volume stock, it’s a good stock to leave a low priced order in that can get hit when a few big shareholders need to sell. 


    StoneMor Partners (NYSE:STON): A rare income play on cemeteries.



    5.   Utilities

    All of the below are classic cases of blue chip companies with formerly modest blue chip style dividends beaten down mostly due to wholesale selling across the markets. While they remain at 10 year lows, their dividends, while not huge, have become serious. While major economic downturns will slow down their growth rates, things need to get very bad before their dividends get cut. Buy only when market is down and yields are over 6%.


    Dominion Resources Inc. (NYSE:D)


    Duke Energy Corp (NYSE:DUK)


    Progress Energy (NYSE:PGN)


    Southern Company (NYSE:SO)




    Here in Part 11B we concluded or mid-series review.


    The coming articles will examine individual categories and stocks in greater detail.


    Disclosure: I have positions in most of the above mentioned investments.


    Interested in learning more about investing in stocks that provide reliable high dividends with better transparency, appreciation potential, and liquidity than bonds? Visit http://highdividendsto... Watch for info on our quarterly newsletter.



    Apr 28 6:12 AM | Link | Comment!






    For my regular readers the below may seem a bit repetitive. However, the fundamentals of good teaching include constant repetition, summary, and drill. 


    Thus it's critical to occasionally review the key points of income stock investing.

    So, dear readers, here's a review of the Must-Avoid 7 Deadly Sins for Income Investors.


    Part 11B will briefly review the best of the specific recommendations covered thus far in this series.


    1. Ignoring the Overall Market Trend

    While you don't have to attempt to time market tops and bottoms, one should always be aware of the markets' overall trend.  In particular:


    A. If the market is in an established downtrend

    Invest only funds you can let sit, and be very selective about what you do buy. Also, because down trending stock prices usually move in a downward channel, set your buy prices near the lower range of that declining channel if you want to try to get the lowest near term price.




    Don't confuse this with picking an overall bottom. In an established downtrend, assume prices will ultimately head lower until there are clear signs of a reversal.


    B.  If the market is in an established uptrend

    You can be more aggressive, accepting lesser yields for stocks that are appreciating with the idea that you'll take some profits when the trend fades. Again, however, stocks don't trend straight up or down. Usually up-trending they fluctuate within a rising channel, so try to set your buy prices near the lower end of the rising channel.



    C. If the market is in a trading range

    Set your buy orders at the low end of the range (support) and consider taking at least some profits at the upper end (resistance).







    2. Ignoring Likely Support and Resistance Points – The Keys to Knowing When to Buy and Sell


    Those familiar with technical analysis can skip this section.


    While income investors are justifiably more inclined to be long term buy and hold investors, they should still be well versed in enough technical analysis and chart reading to identify support/resistance price levels for choosing buy prices (or selling puts for extra income) and resistance levels for selecting points to consider taking some profits (or selling some covered calls for extra income).


    A. Definitions


    What are these? In their simplest forms:


    A support level is simply the lowest price that a stock has reached over a given period before stopping its decline and then reversing direction and rising. It’s like getting the stock on sale. The more times that level has been reached but not breached, the more tested and reliable it is.


    A resistance level is the highest price a stock has reached over a given period before halting its rise and then declining. The more times this peak price has been reached but not penetrated, the more tested and reliable it is.


    In short, support and resistance define the likely lower and upper range in which a stock price fluctuates over a given time.


    Note: Once breached, support becomes resistance, and resistance becomes support. In other words, if a stock had never declined over the past 5 years below $10 and then falls below it and stays below for more than a brief period, the prior $10 support level is now consider a resistance level. That is, as the stock price approaches $10 it will be expected to retreat and thus this might make a good selling point. If, however, the stock rises above $10 and stays above it, that price again becomes a support level.


    There is plenty of good, free information online about the different kinds of support and resistance price levels. Some, like trend lines and price support levels, will make intuitive sense. Others, like Fibonacci retracements and extensions, may not.


    However the following list of types of support and resistance are widely followed and used, making their influence a self fulfilling prophecy by virtue of their sheer popularity.


    So if you want a clearer idea of when to buy (or sell puts) or sell (or sell covered calls), study the following concepts.


    B.  Basic Types


    Most Basic

    Definition of price support and resistance

    Trend lines


    Moving Averages

    Bollinger Bands


    More Advanced

    Fibonacci retracements and extensions

    Parabolic SAR

    Classic chart price patterns

    Classic candlestick patterns


    There are many more I could give here, but this section is obviously for those new to technical analysis.


    C. Sources of Free Study Materials


    1.   Your own internet search


    To search out free sources on basic technical analysis, use search terms like:


    “Technical analysis” AND Introduction

    “Technical analysis” AND (support OR resistance)


    2.   A few specific recommended sites include:


    General Investing Education Sites


    Foreign Exchange Trading Sites

    Because technical analysis is so heavily used in forex trading, these sites often have good education resources on various aspects of technical analysis. Once you learn about it and want to test your ability to use it, they also provide free practice accounts for 30 days where you can try to paper trade and test yourself. There are many, but here are a couple I liked.

  It’s concise and clear, a good place to start for a quick overview. I also found their email and live chat support very responsive and helpful when questions arose. If you want to practice technical analysis with a free practice account, their trading platform was easy to use and had good yet easy charting tools. I’m involved with forex trading, and my experience with them thus far has been good.


    To access their free technical analysis materials:

    Click on the RESOURCES tab on the upper horizontal navigation bar, then

    Click on Education Center at the top of the left margin

  A wide selection of often good but brief technical analysis topics. Choose from a variety of levels and subjects in the left margin



    3. Assuming Lower Yield Is Necessarily Safer

    Many intuitively equate lower yield with greater stock price or dividend stability.  Yes, in theory, perfectly functioning markets should automatically and instantly assign safer companies lower yields and vice versa in relation to their perceived risk levels. In fact, perceived risk and reward usually are inversely related, especially in periods of relative market calm.


    However, markets are often neither rational (especially during historically extreme bull or bear markets) nor fully informed, nor up to date with reality. In strong bear markets such as this one, even solid stocks sell off with the general market as investors indiscriminately sell stocks to raise cash and reduce risk of further loss. Thus their yields rise proportionally.


    For example, if a stock cost $10, and pays $1 of annual dividends, it yields 10%. If that price drops to $7, yet net income or funds from operations (in the case of MLPs and certain income funds) remain stable, the dividend holds steady, and the stock now yields 14%. In this case, the yield does not reflect increased business risk. Of course, it may, if the stock is cyclical and performs along with the overall economy, as is the case with many non-essential consumer and luxury goods stocks, heavy manufacturers, real estate, etc).


    Thus the high yield can simply reflect the overall market's weakness or misperception, not necessarily a problem with the company. This is especially true for dominant companies in recession resistant niches like utilities or other power generators, firms with largely fixed revenues via long term contracts with stable customers, dominant or near monopoly suppliers of critical services or products like energy infrastructure MLPs or income funds, certain communications service providers, etc.


    Again, virtually all stock prices follow the market. Thus even the largest, theoretically more stable firms' stock prices drop in approximate proportion to the overall market along with medium and small cap stocks in more recession proof niches that may offer better yields and performance.


    A. Defining Acceptably High Yields

    While what constitutes an acceptably high yield for income is debatable, it's clear that the typical sub-5% yields seen in blue chips or "dividend aristocrats" companies will leave you with virtually nothing after real inflation and taxes.


    Yes, over time they do grow their dividends, but rarely is that annual growth dramatic enough to make a significant difference. For example, if the annual yield is 3%, and the company raises the dividend 10% (an unusually high rate of dividend growth) you're still only getting 3.3% per year. Real inflation (i.e. the actual cost of living for those of us who eat, use energy, education, medical services etc) is usually well above that level.  You need a large principal invested at that rate to have anything left after real inflation and taxes.


    One of the few upsides of strongly bearish markets such as this one is that it’s possible to find very solid companies with reliable yields above 8%, because:

    Even prosperous companies see their stock price pummeled and thus their dividend yields rise in proportion to the price declines as panicky institutions (who hold most of the shares) and individuals sell indiscriminately


    Even when panic selling subsides, the residual heightened fear in bear market raises risk premiums as investors wait buy only the most tempting (i.e. lowest price, highest yielding) bargains.


    Thus under these conditions, I try to find quality companies yielding at least 8%. Yes, high inflation and taxes could wipe this out too, as could selling at a loss greater than your income. That's true for every stock.



    B.  Low Yield Dividend Stock Investing Is not the Same Thing as Income Investing


    However, your odds of profiting are obviously better with steady high yields than with steady low yields.


    With low dividends, your only chance to really profit is with price appreciation, which will be hard to get until the market enters a sustained uptrend, which is currently not expected.  The most optimistic speculation is for a flattening market remaining in a trading range for the coming years. That means short lived rallies. Try to catch them early if you can, but that's attempting to time the market. Few are consistently successful at that.


    Remember, stock prices follow the overall market, and the shares of larger, more established firms have been hit just as badly as those of smaller firms.


    4. Neglecting to Check If the Yield Is Sustainable


    On the other hand, the underlying business must be able to sustain and ideally grow the dividend. Whether you do the research yourself or use a newsletter like mine, it's critical to check the sustainability of the dividend. As mentioned in prior articles, you need to focus on overall business health, and especially on payout ratios and how income, funds from operations, and cash levels compare to current and future debt obligations.


    5. Failing to Calculate Minimum Needed Yield

    If you need $80,000/ year, and you have $500,000 to invest, what overall yield do you aim for? Divide income be principal: 80,000/500,000 = 16%.


    Ok, 16% is not realistic under current conditions unless one accepts higher risk levels or we get further periods of panic and new lows that produce opportunities for such yields. That may yet happen, though it will take courage to take substantial positions at that point.


    But this illustration does show that the investor needs to be pushing for the highest reliable yields possible.  Those with larger portfolios can be afford to diversify more into lower yielding stocks, those with smaller ones will need to choose between a narrower focus on higher yielding albeit quality stocks, and a somewhat lower yield with a more diversified mix and theoretically lower risk.


    6. Failure to Diversify Currency


    In the not so distant past this was almost irrelevant for US investors, who for generations had held the world’s safest currency backed by the world’s most stable economy. No longer.


    Now currency diversification has become critical, and failure to do so will probably be the biggest single mistake most U.S. income investors will make in the coming years.   


    With the US government committed (thus far) to printing about $13 Trillion in new dollars, (about a year’s worth of US Gross National Product) a steep devaluation in the USD's purchasing power seems inevitable at some point, and major overseas buyers of US dollars are very unhappy about that. Understandably, the major buyers of US Treasury bonds like China and Japan would like to further diversify out of the US dollar. Admittedly, though, it’s unclear how they’ll do this without hurting their own reserves or exports. Assuming they ultimately do reduce their demand for US Treasury bonds, this means declining overseas demand for dollars and thus further pressure on the USD likely at some point in the coming years.  


    This is a massive problem for income investors based in US dollars.


    Why? Because income investors are by definition usually in liquid currency denominated assets, their fate is tied to the currency in which that security is denominated.


    The solution is to own stocks and bonds denominated in different currencies (some more based on exports (Yen, CAD, AUD) some more on capital flows (GBP).  


    Caution: All other currency groups are also expanding money supply, and few are successful at predicting foreign exchange trends. Thus some diversification into high dividend investments that are based in other currencies is essential.


    7. Failure to Invest in Inflation Resistant Stocks


    Unfortunately, protecting your purchasing power will be more complicated than merely buying income stocks tied to other currencies. All currency blocks are expanding their money supplies, and that will at some point lead to erosion in their purchasing power, aka inflation.


    What makes a stock inflation resistant? The ability to pass on rising costs to its customers, aka pricing power.  This comes from businesses based in some kind of vital tangible asset or vital commodity, the price of which rises in proportion to the dollar’s decline. Energy, precious metal, agricultural and other key commodity businesses fit this category. Pricing power can also come from being a dominant or monopolistic provider of a critical service that allows the firm to pass along increased costs to customers. For all the bad press about them, certain large and rural telecommunications companies are good examples of this, as are certain energy infrastructure MLPs in the US and Canadian clean energy and energy infrastructure firms.



    8. High Dividend Stocks To Consider


    Our newsletter discusses these in more detail, but see Part 11B for a brief review of the best stocks covered thus far and of stocks to be examined in future articles in this series on The High Dividend Investor’s Collapsing Dollar Survival Guide.  









    9. Conclusion, Disclosure & More Info


    Here in Part 11A of this series on the High Dividend Investor’s Collapsing Dollar Survival Guide, we reviewed key mistakes that income investors must avoid in order for their portfolios to survive and prosper.


    In Part 11B we’ll briefly review the best of stocks covered thus far and still to be covered.


    Disclosure: I have positions in most of the above mentioned investments.


    Interested in learning more about investing in stocks that provide reliable high dividends with better transparency, appreciation potential, and liquidity than bonds? Visit http://highdividendsto... Also, watch for coming notice of our quarterly newsletter, the High Dividend Stocks Guide Newsletter.






    Apr 28 6:03 AM | Link | Comment!
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