How Doctors Quadruple Their Income Making This House Call

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Includes: ARCC, CTL, DHI, ED, EPR, GEO, GOV, MAIN, MO, O, OHI, PHM, RAI, RMR, STON, SUI, T, TOL, VGR, VZ, WPC
by: George Schneider

Summary

Remember the good old days? You got sick, mom called the doctor. Lickety split, the doc was ringing your doorbell to soothe what ailed you.

Those days are gone, but doctors and ordinary investors alike have found a way to replace those house call revenues by selling covered calls on housing companies.

When low interest rates have squeezed savers and investors out of safe CDs, investors can adapt and find new ways to increase their income, even above dividend payouts.

Buy Alert: We executed a buy/write strategy Thursday to enhance subscriber portfolio income. We bought 500 shares of PulteGroup (NYSE:PHM) at $18.78 per share and simultaneously sold 5 PHM calls, strike price $19, maturity October 21, 2016, for $1.27.

Subscribers received an early action email alert to take advantage of this strategy.

Because we sold this call, $635.00 was credited to our subscriber account:

5 calls represents 500 shares X $1.27 = $635.00

The $.36 per share dividend adds $180.00 to our annual income.

Higher Interest Rates Could Be Good For The Housing Market

Despite the rising chances of a Fed interest rate hike next month or in July, The S&P 500 (NYSEARCA:SPY) has been resilient this week. Though this sounds counter-intuitive at first blush, it is in part due to strong housing data. Strong data on U.S. new home sales in April, which grew at the fastest rate in eight years, supported the view the economy may be strong enough to withstand an interest rate increase as early as June. One key housing executive, among others, agreed. During Toll Brothers (NYSE:TOL) second quarter conference call on Tuesday afternoon, Chairman Robert Toll said that rate increases could actually spur demand.

What you have with a price increase is an increase in demand created because the price has gone up, which by the way may come to us in the summer months this year," he said.

If the Fed goes up and the mortgage rates go up an eighth or a quarter, it probably means price increases are coming soon, which spurs demand and spurs action. So it's too early yet to tell, but we could be onto something good."

The idea here is that when rates are increased, this catalyst along with already increasing house prices, will finally get millions of prospective buyers off the sidelines to purchase the home they've wanted. This pent-up demand will add to the already robust pick-up we've seen in demand this past month, with purchases of new single-homes jumping 16.6% from a month earlier to a seasonally adjusted annual rate of 619,000. According to the Commerce Department that was the fastest pace since January 2008.

Yes, the fastest pace of sales since 8 ½ years ago, In addition, the median price of a new home rose to $312,100 last month which was up 9.7% from a year earlier and the highest level on record.

Gus Faucher, deputy chief economist at PNC Financial Services said:

The fundamentals for new home sales are good and getting better: more jobs, rising wages, more household formations and very low mortgage rates."

Tuesday's Commerce report also showed inventories of new homes tightened in April. At the current sales pace, it would take 4.7 months to exhaust supply compared to 5.5 months during the prior month. 5.5 months is considered a more historical average supply. A number below that indicates tighter supply which exerts an upward push on prices. This, plus historically low mortgage rates and the prospect of rising rates and a strengthening labor market could be the secret sauce that kicks this housing recovery into boom mode.

U.S. home prices rose 5.7% in the first quarter of the year from a year earlier, according to the Federal Housing Finance Agency (FHFA). This marked the 19th consecutive quarterly gain.

BobToll, of Toll Brothers, added that a recent U.S. Census report indicated suburban populations are on the rise, which is supportive of the new home market.

As millennials mature, studies indicate that their appetite for homeownership is consistent with past generations, which is, of course, encouraging for our industry," he said.

Toll reiterated the importance of the strong April new home sales data.

The release stated this represents a supply of 4.7 months at the current sales rate. With a little bump in demand we could be off to the races," he said.

U.S. Home Prices Rising

Another Word From The Fed

Bullard: tight labor market may put upward pressure on inflation

Adding to the daily drumbeat by Fed presidents hawking for a rate increase, on Thursday, St. Louis Federal Reserve President James Bullard said:

By nearly any metric, U.S. labor markets are at or beyond full employment."

Actionable: Milk Greater Income From The Coming Housing Boom

There are several ways to profit from this Spring's housing boom. Selling covered calls on specific home builders presents such an opportunity.

What is a covered call, anyway?

A "covered call" is an income-producing strategy where you sell, or "write," call options against shares of stock you already own. Typically, you'll sell one contract for every 100 shares of stock. In exchange for selling the call options, you collect an option premium. But that premium comes with an obligation. If the call option you sold is exercised by the buyer, you may be obligated to deliver your shares of the underlying stock.

Fortunately, you already own the underlying stock, so your potential obligation is "covered" - hence this strategy's name, "covered call" writing.

This strategy is a time-honored method and is considered quite conservative. The goal is to generate income from the call premium that you sell to the buyer of the call. This premium plus the dividend on the underlying shares can give quite a boost to the income investor's overall income.

This buy-write strategy is especially effective in the sideways, narrow channel market we've been negotiating for the past 18 months. The ideal for the call writer would be for the stock to stay in a narrow range in concert with the market and simply collect call premiums plus dividends and never have the stock called away from him.

PulteGroup - A Home Builder Buy-Write Candidate

Traders are looking for gains in PulteGroup by the end of next week.

1,600 Weekly $18.50 calls expiring on June 3 were purchased for $0.38 to $0.50 Wednesday. This represents fresh buying, as volume was well above the strike's open interest of 370 contracts.

Long calls lock in the price where call buying investors can buy stock, allowing them to profit from a rally with limited capital at risk. Their cheap cost can also generate significant leverage on a percentage basis if shares move in the right direction.

For example, a call buyer buys a call on ABC stock, currently selling for $9.00 per share, and pays $1.00 on a call 6 months out and a strike price of $10.00. That's referred to as an out-of-the-money call.

If, at any time over the next 6 months, the price of ABC rises over $11.00, he can exercise his option to buy those shares at a strike price of $10.00. His costs were $1.00 to buy the call, plus $10.00 for the stock = $11.00 out of pocket costs, plus commissions.

Now, if the stock goes to $12.00, it can be said that he has profit of $1.00 on his initial $1.00 investment.

His profit, if he sold, is:

$1.00/$1.00 = 100%.

In practice, if the option goes in the money and if there is still a good amount of time till option expiration, the price of the call option, once the stock goes past the strike price, moves dollar for dollar with the price of the stock. So, his $1.00 investment might then sell for $2.00 or more if there is a lot of time left till expiration, and if he wished, could simply sell the option to close out his position and take his $1.00, or 100% profit in that way. This is the power of leverage working for the option buyer.

PHM rose 5.11% to $18.73 Tuesday, rallying with other homebuilders on the surprise surge in new home sales referenced above, but shares are down 6% in the last month. The company's last quarterly results on April 21 were bullish, and its next earnings report is expected on July 28.

Overall option volume was 3 times greater than average Wednesday.

Let's Look At Our Options, As Sellers and Income Investors

PHM - Sell October 21, 2016 calls with $19 strike price, for $1.27. Receive 6.76% plus 22 cents if called before expiration. Plus, receive two dividends of $.09 each, for $.18 additional income if not called.

Total gain, if not assigned is $1.27 premium plus $.18 in dividends = $1.45

$1.45/$18.78 price = 7.72% for five months, translates to:

7.72%/5 months = 1.54% X 12 months = 18.53% annual return if not assigned

If assigned before expiration, the gain would be:

$1.27 premium + $.22 (difference between current price and strike price) = $1.49

Any dividends received before assignment belongs to you, giving you an additional gain of perhaps $.09 or $.18 depending on when assignment of shares was made.

So, the minimum return from this position would be:

$1.49/$18.78 = 7.93%

If one dividend is received before assignment, the return would be:

$1.58/$18.78 = 8.4%

If assignment occurs after the second dividend is received, the return would come to:

$1.67/$18.78 = 8.9%

The sooner the assignment occurs the greater your annualized return from this strategy.

For instance, let's imagine you sold the call today. You get $1.27 immediately credited to your brokerage account.

The stock, currently selling at $18.78, spikes to $19 within a week (not hard to imagine with all the excitement surrounding the housing recovery now).

The stock is assigned and you are paid $19 per share for your shares. Here's the result:

$1.27 premium you were paid when you sold the calls, plus $.22 (difference between what you paid for the shares, and what you received on the assignment of shares) = $1.49

$1.49/$18.78 = 7.93%/52 weeks = .15%

Annualizing this return: .15%X 52 weeks = 7.93%

Let's compare this annualized return to dividends alone:

$.36/$18.78 = 1.9%

7.93%/1.9% = 4.17

By selling a covered call on PHM today, the investor can get a return that is 4.17 times greater than simply buying shares of this housing company and receiving the dividend.

Let's Compare Another Of Our Options

D.R. Horton (NYSE:DHI)

Sell the November 18, 2016 calls with a strike of $31 for $2.30. The stock is currently selling for $30.48.

Total gain, if not assigned is $2.30 premium plus $.16 in dividends (2 payments of $.08 each). = $2.46

$2.46/$30.48 = 8.07% for six months, translates to:

8.07%/6 months = 1.35% X 12 months = 16.2% annual return if not assigned

If assigned before expiration, the gain would be:

$2.30 premium + $.52 (difference between current price and strike price) = $2.82

Any dividends received before assignment belongs to you, giving you an additional gain of perhaps $.08 or $.16 depending on when assignment of shares was made.

So, the minimum return from this position would be:

$2.82/$30.48 = 9.25%

If one dividend is received before assignment, the return would be:

$2.90/$30.48 = 9.51%

If assignment occurs after the second dividend is received, the return would come to:

$2.98/$30.48 = 9.79%

The sooner the assignment occurs the greater your annualized return.

Again, let's imagine you sold the call today. You get $2.30 immediately credited to your brokerage account.

The stock, currently selling at $30.48, spikes to $31 within a week (that's only 1.7% away from the current price).

The stock is assigned and you are paid $31 per share for your shares. Here's the result:

$2.30 premium you were paid when you sold the calls, plus $.52 (difference between what you paid for the shares, and what you received on the assignment of shares) = $2.82.

$2.82/$30.48 = 9.25%

9.25%/52 weeks = .178%

Annualizing this return: .178%X 52 weeks = 9.25%

Let's compare this annualized return to dividends alone:

$.32/$30.48 = 1.05%

9.25%/1.05% = 8.81

By selling a covered call on DHI today, the investor can get a return that is 8.81 times greater than simply buying shares of this housing company and receiving the dividend.

You don't have to be a doctor to make money on house calls

Using the Watch List Real Time Tracker to compare these two home builders revealed the dividend profiles, dividend yields and income from each position.

P/E ratios, daily and 52-week trading ranges and a host of other important metrics that helped analyze the best prospect are also on display. We can immediately see that for an outlay of a bit more than half the outlay for DHI, we are receiving almost the same yearly income from this position. Of course, this is due to the dividend yield of PHM being almost twice that of DHI. The P/E reported by the tracker allows us to see that the purchase of PHM comes with a lower P/E than that of DHI, giving us a better margin of safety, once again:

12.88 vs. 14.02

Scrolling to the right allows us to examine those comparable metrics and see upcoming ex-dividend dates and dividend pay dates.

DHI is selling for an 8% discount from its 52-week high, while PHM is selling at a much greater discount, 15% below its 52-week high. Again, this is an additional margin of safety afforded our new purchase.

Watch List Real Time Tracker

When we compare the possible outcomes of these two positions, our decision is to go with PulteGroup. The total outlay to establish this buy/write position is a little more than half of that required for the DHI position. This saves our dry powder for establishing additional positions for the subscriber portfolio in future.

The PHM strike price is just 1.1% above the current stock price, putting it closer to getting into the money than DHI which is about 1.7% away from strike price.

The dividend we'll collect on PHM is double what we'd get from the DHI dividend, giving us higher income right off the bat.

If the shares are not assigned and we get to keep our shares, the annualized return for the PHM position is 18.53% compared to just 16.2% for DHI.

The slightly lower return on the assigned case is acceptable for the lower risk entailed in this position. I would rather accept half the possible return of the more risky DHI position. After all this projected return and enhancement of our income is 4.17 times our income from just the dividend alone, and that's not bad.

Real Time Portfolio Tracker

The real time tracker enables us to examine current portfolio positions in relationship to income production from each component.

Reduce Risk By Weighting Positions To Equal Income

On occasion, a reader will ask me, "Aren't you violating the principal of diversification by demonstrating the purchase of one or two stocks?"

Read on, and you'll discover that we have well-diversified portfolios that we manage here on Seeking Alpha and for our subscribers. We have added this buy/write position to the subscriber portfolio and subscribers received early notification if they wished to mirror this trade. The closer we hew to this principle of weighting our positions to provide essentially equal amounts of dividend income, the more we de-risk the portfolio for any future, possible dividend cut. Our diversity of sectors and number of constituents impart some level of risk mitigation. Should one or two components reduce their dividend at any point in the future, our income would temporarily decline by perhaps 5% or so, depending upon the severity of the cut. If such a position were to be sold, the proceeds would be reinvested in another more promising name and most of the preceding dividend income would be restored.

When stocks fall to better-timed entry points, we buy shares in order to grow portfolio income. To gain some of these better-timed entry prices that enable me to receive higher yield and income, I use the Watch List Real Time Tracker to alert me and serve as my research and trading assistant.

I used the other digital utility tool I built, the Real Time Portfolio Tracker, to discover additional share positions necessary to bulk up in share count in order to bring its annual income closer to parity with the other positions in the portfolio. Column O on the extreme right of the sheet clearly indicates what percent of portfolio income each component contributes, so a quick glance delineates the positions that need fattening, all data being updated in real time, all day.

Patience And Discipline To Wait

I recently authored a piece called, "Patience Pays Retirees Bigger Dividends." Bigger dividends than what, you may ask? Bigger dividends than if you simply allowed the market to dictate prices to you. Today's piece was geared toward another example of how we may use different strategies to enhance our income and not simply allow the market to dictate price. Diametrically opposed, this buy/write strategy uses market prices to examine which position, which strike price and call maturity best fits our needs to grow income for the portfolio.

Instead of using pencil and paper to keep a running list of candidates I'd like to add to my portfolio, or to those I manage here on Seeking Alpha or for subscribers, I use digital tools to help guide me to better-timed entry prices. Instead of trying to keep track of all possible candidates in my head or on a diner napkin, these tools allow me to name my price and not have the markets dictate to me.

Finding ways to take control of the investing aspects that we can in fact control, these concepts will guide us toward the higher yields and higher income that we all seek for our retirements.

Lessons Learned

We have learned here that there are actions that can be taken to utilize stock pricing, call pricing and length of maturities to grow our income beyond what dividends alone can give us. Over the long haul, these approaches give us the benefit of capital preservation, capital growth and income growth, all at that same time.

The Fill-The-Gap Portfolio At A Glance

I began writing a series of articles on December 24, 2014, to demonstrate the real-life construction and management of a portfolio dedicated to growing income to close a yawning gap that so many millions of seniors and near-retirees face today between their Social Security benefit and retirement expenses.

The beginning article was entitled "This Is Not Your Father's Retirement Plan." This project began with $411,600 in capital that was deployed in such a way that each of the portfolio constituents yielded approximately equal amounts of yearly income.

The FTG Portfolio Constituents

Constructed beginning on 12/24/14, this portfolio now consists of 18 companies, including AT&T, Inc. (NYSE:T), Altria Group, Inc. (NYSE:MO), Consolidated Edison Inc. (NYSE:ED), Verizon Communications (NYSE:VZ), CenturyLink, Inc. (NYSE:CTL), Main Street Capital (NYSE:MAIN), Ares Capital (NASDAQ:ARCC), Reynolds American, Inc. (NYSE:RAI), Vector Group Ltd. (NYSE:VGR), EPR Properties (NYSE:EPR), Realty Income Corporation (NYSE:O), Sun Communities Inc. (NYSE:SUI), Omega Healthcare Investors (NYSE:OHI), StoneMor Partners L.P. (NYSE:STON), W.P. Carey, Inc.(NYSE:WPC), Government Properties Income Trust (NYSE:GOV), The GEO Group (NYSE:GEO) and The RMR Group (NASDAQ:RMR).

Because we bought all of these equities at cheaper prices since the inception of the portfolio, the yield on cost that we have achieved is 6.59%.

Monitoring Portfolio Positions and Growth Of Income

In an effort to stay connected to our portfolio dividend income and the growth of that income, I'll enter our positions in both the public Fill-The-Gap Portfolio and subscriber portfolio into the Dividend Growth and Income Spreadsheet. It keeps me focused on my bottom line of producing income. When dividends are raised, I'll enter that into the assigned column. My algorithms then compute for me my new income on each portfolio constituent, the new income when a raise occurs, the yields, the increased percent of income and total portfolio income. This focus helps keep me on track toward my goal of building and growing income.

Dividend Growth and Income Spreadsheet

FTG Recap

Currently, the Fill-The-Gap Portfolio is producing $27,140 in annual income. When added to the average couple's Social Security benefit of $28,800, we have, in only 16 months' time, significantly exceeded our goal of filling the gap between Social Security income and a comfortable $50,000 retirement. In fact, our total income, between these two sources, is now $55,940, which is $450.00 more than last month's income. This is due to the dividend increases we received this month and our reinvestment of dividends into more GOV shares and the new dividend income attendant to this purchase. It may be only a few more months till our dividend income exceeds Social Security benefit income.

We have experienced no cuts, and no elimination of dividends in 16 months of portfolio management. On the contrary, we have enjoyed a regular stream of dividend increases, more than enough to keep us comfortably ahead of inflation.

As of this writing, midday Thursday, this year alone, the FTG has grown $35,856 in value, or 7.96%, while the Dow is up only .2.34% and the S&P 500 is up just 2.32%. Accordingly, the Fill-The-Gap Portfolio has effectively outperformed the return on the Dow Jones Industrial Average by more almost 4 times, and has grown almost four times greater than the return of the S&P 500 Index.

MY FTG Mirror Calculator

After doing their own due diligence, readers wishing to proportionately emulate FTG Portfolio trades for their own portfolios use the "My FTG Mirror Calculator" or the "My RODAT Mirror Calculator" to simplify their task.

Author's note: Should you be interested in reading any of my other articles detailing various strategies to enhance your returns on a dividend growth portfolio, you will find them here.

As always, I look forward to your comments, discussion, and questions.

We are currently offering a FREE two-week trial of my subscription service. To learn more about this premium service, please click this link:

Retirement: One Dividend At A Time

Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.

Disclosure: I am/we are long ALL FTG PORTFOLIO STOCKS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.