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Using Stock Options to Pay Yourself 5% Monthly Dividends

Sometimes we forget the basics.

In our video series, there's a lesson called "The Secret to Consistent 20-40% Annual Returns on Stocks" and I hope you've seen it.  Although the low implied volatility of the market has made it a rough year for option selling, we were still able to scratch out just over 40% profits in four months in our paired Long-Term and Short-Term Portfolios.    Our other virtual portfolios are also performing very well with the Options Opportunity Portfolio up over 30% in 2016 and, surprisingly, our very conservative Butterfly Portfolio is up over 60% due to some not very conservative bullish adjustments we made in the February dip.  On the whole, though, we accomplished all this by following the BASIC strategies we teach at Philstockworld, not by gambling! 

Not that we're adverse to gambling, gambling is fun – but fun means fun, which means it's a small part of our total investing portfolio while the vast bulk of our money is SENSIBLY INVESTED in safer strategies that are designed to grind out consistently good returns over many years.  We have discussed the long-term advantages of compounding annual growth in "How to Get Rich Slowly" and now we'll begin discussing some basic strategies that will help you generate those consistent annual returns to put you on a path to a healthy, wealthy retirement.

In the "7 Steps" video, we're discussing a basic covered call strategy and we delve into the Fundamentals of stock selection.  At the time (Sept 2013), we were using ABX, which was trading at $19.15 and we sold the November $19 calls (45 days out) for $1.30.  The simple instructions were to wash, rinse and repeat to make up to 40% a year by simply selling calls against the stock.  

As you can see, ABX has dropped as low as $6.57 since then, down about 65% BUT, had you followed through and kept selling calls, we had a lovely 12-month period in which it stayed in our range and that would have given us 8 opportunities to collect at least $1 for $8 back before the stock turned down in September of 2014.  That would have dropped the net outlay below $10 and stopping out at $15 would have been a 50% gain for the year – even as the stock dropped 22% (from $19.15 to $15).

Even if we stuck with the stock as it kept going lower, there were 15 more months of flat or dropping action in which, even if we collected just 0.50 per month, it's another $7.50 off our basis, bringing it down below $2.50 and eventually stopping out at $7 would be a 180% gain – despite the stock going 65% in the wrong direction!  Now are you interested in learning more about this "boring" system?

You can't get more basic than this – just mindlessly selling covered calls every month or two and, even when the stock ends up being a dog – 180% returns!  There's nothing fancy here other than our selection of a range-bound stock which, of course, we stop playing when it falls out of our range.  

ANYONE can learn how to trade this way (and we go over all the strategies in our book, of course) yet, unfortunately, a lot of traders tend to FORGET how EASY it is to make money by just sticking to the basics.

As with the Dark Side, it is easy to be seduced by the allure of quick and "easy" money using options for leverage and trying to beat the market for a big win based on some "tip" you got, be it from a friend or a guy on TV or even someone like me.  THAT'S GAMBLING!!!  

Never forget that that's gambling and you will be OK.  Gambling is NOT investing.  Investing is what we should be doing with the vast bulk of our equity assets – gambling is not!  See our series on Smart Portfolio Management, which has examples for $10,000, $100,000 and $1M+ portfolios.  We demonstrate a lot of these trades for our Members during the year using 4 virtual portfolios with various sizes and trading styles.

BUT, as I said above, sometimes we just forget the basics – the reason we love options in the first place.  We can sell a put to give ourselves a discounted entry on a stock and we can sell a call to pay ourselves a dividend.  Year after year we demonstrate how these techniques can give you those consistent 20-40% annual returns WITHOUT taking huge risks and this coming year, our concentration is going to be on having our Members EMBRACE those long-term wealth building strategies.

If you believe investing is gambling, then you are doing it wrong and, if you believe investing is gambling – you are more likely to take the kind of risks that ARE gambling, which will then reinforce your misguided view that investing is gambling – get it?

There is no gambling in buying ABX TODAY, for $18.40 and selling the June $18 calls for $1.40.  Your net entry is $17 and, on June 17th (34 days), you will either be called away at $18 with a $1 profit (5.8%) if the stock is above $18 or, if ABX is below $18, you will own the stock for net $17 (a 7.6% discount) – at which point you will wash, rinse and repeat the trade by selling the July $17s for $1.40 or so, dropping your basis to $15.60, 15% below the current price.   

This is not an options class so I won't get into all the what-ifs down the road.  Suffice to say you can repeat the performance that gave us eventual profits on ABX in the past with very little risk.  Now, our Members know there are fancier ways to go, so let's pick another example and see if we can make it more interesting than 5.8% in 34 days.  

Remember, we want to find stocks that are likely to stay in a channel.  Stocks that have decent volatility day to day (to boost the price of the options we sell) but are not too likely to stray from a trading range of maybe 20% up or down.  WMT comes to mind, MCD, VZ, T, F…  Blue chips are good when you are beginning, as they are less likely to go to zero. 

We'll start with F, because F is only $13.22 a share so anyone can play with it.  Option contracts trade in 100-share blocks so SELLING the 2018 $12 put for $1.50 obligates you to buy 100 shares of F for $12 ($1,200) and puts $150 in your pocket right away.  That nets you into the stock for $10.50, which is giving yourself a quick 20.5% discount (see "How to Buy a Stock for a 15-20% Discount").  

You can then conservatively buy 100 shares the stock for $13.22 ($1,322) as well and that would put you in at a net of $11.72 a share and, if F goes below $12 and the 100 shares are assigned to you, then you end up with 200 shares at an average of $11.86 ($2,372) – that's your maximum risk on the trade (and F is not likely to go to zero, of course).  Now you can sell the June $12.75 calls for 0.70, putting another $70 in your pocket, so the total cash outlay drops to $1,102.

If you are called away in June $12.75, you get paid $1,275 in cash, keep the $70 from selling the calls and the $150 from selling the puts and you are left with just the obligation to buy 100 shares again at $12 (if the stock goes below that price by Jan 2018).  That turns you initial net $1,102 into $1,275 (+$173 or 15.6%) in 34 days.  If you do end up having to buy 100 shares of F in 2018 for $1,200, the $173 you made reduces your net cost to just $1,027 or $10.27 per share – 22.3% off the current price!  

So clearly there is no reason to fear the upside and the downside is F goes lower and you keep the $220 you've collected and, in July, you sell another call for another 0.70 and now you have $290 in your pocket for August and $360 in Sept and $430 in Oct and $500 in Nov and $570 by December.  A year from now – if you are NOT called away with more than a 20% profit, you will have $850 in cash and the F stock you bought for $1,102 and that's net $252 on your first 100 shares + $12 for the next 100 (since, clearly, we'd be under $12 by then) would be $1,452 for 2,000 shares or $7.26 per share (45% off the current price).

Of course, if F is lower than $7.26 (down 45%) in a year, you do lose money.  As I often say to our Members, these are not magic beans – there is some risk, BUT – by intelligently managing our risk, we have a much more likely upside than downside and MOST of the time, we can make some very nice returns.  

Now, there's a fancier way to play F and that's what we call an ARTIFICIAL buy/write where, instead of owning the stock (which pays a nice 4.5%, 0.60 dividend, according to Dividend.com), we instead buy the 2018 $11.75/16.75 bull call spread for $1.75, selling the same $12 puts for $1.50.  That drops our net cash outlay to just 0.25 and we're only obligated to buy 100 shares for net $12 ($1,200) but we can STILL sell those calls.

Since our cash outlay is now 0.25 though (and margin required is $1.44 per contract) and since we don't have any stock to call away, our goal should be just to collect 10% per month of the $1.69 cash+margin we've committed to the trade – otherwise we are engaging in the great sins of greed and over-leveraging.  

Looking to make 0.17 per month is easy.  We can, for example, sell the June $13.75 calls for 0.17 and see how that goes before selling more.  That's a very easy way to quickly generate 10% monthly returns while your upside risk doesn't kick in until F is over $16.75 – the top of your spread (otherwise you just roll your short calls along on months you don't collect the cash).  

Again, not magic beans – some months you will win and some you will lose but, on the whole, when the potential is to make 120% per year if you have 12 winners – there's a HELL of a lot of ways you can end up making 20-40% returns with little trouble. 

As a rule of thumb, if a stock isn't paying 3.5% or better dividend, there's no point in tying up the cash required to own it – so we'll prefer the artificial buy/write to the traditional but both are valid and both are very powerful long-term wealth creation tools that form the basis of our Long-Term Portfolio.

Here's a great list of Top Dividend Stocks by Sector and T is one we often play as they are very steady, year after year and also pay a $1.92 (5%) dividend which, of course, we can enhance using our system.   PFE is ranked #4 on the Dow with a $1.20 annual dividend (3.62%) and we can enhance that nicely – as I noted in our Live Member Chat Room two weeks ago:

Dividend stocks:   So Pat asked me what I think are good dividend stocks but first we need to define what a good dividend stock is.  There are lots of stocks that pay high dividends but they also often carry a high risk of ownership.  We can turn any stock into a dividend stock through options sales and, per example, the other day I mentioned PFE as my favorite because they pay a $1.20 dividend 3% AND I can construct a very conservative play around them:

PFE, for example, at $32.61, pays a $1.20 dividend so he can just buy 500 shares for $16,305 and sell 5 2018 $30 calls for $4.20 ($2,100) and sell 5 2018 $28 puts for $2.20 ($1,100) and that's net $26.21/27.105 (worst case if assigned 500 more, which is 17% off) = $13,105 and, if called away at $30 (10% lower than it is now), he'll collect $15,000, which is + $1,895 (14.4%) PLUS $1.80 in dividends ($900) for another 7% so 29% that way.  Since you are only shooting for 9% - he can do that with 1/3 of what he wants to make the money on and keep the rest on the side – in case the market collapses and other opportunities come up.  

So, to me, If I'm trying to make 5% in a $100,000 portfolio, 1,000 shares of PFE in this spread is $26,210 and you get called away (presumably) at $30,000 (+3,790) plus $1,800 in dividends over 18 months is $4,590 and you're only committing 1/3 of your buying power even in an IRA.  

A trade like that is as low-risk as you get.  It's one of the best dividend stocks.  I also love T, which pays 5%, MO at 3.7%, WM at 3%, WMT at 3%, RRD at 6%, FTR at 7.5%, WIN at 7%, TOT at 5.5%, F at 4.25%, CAT at 4%, CSCO at 3.6%, INTC at 3.25%, KO at 3%, WFC at 3%, GE at 3%  and, of course, our LTP REITs:  ARR (15.2%), CIM (13.4%), CM (4.5%), NRF (12.3%) and STWD (10%).  Some of these are monthly dividend stocks, which is also nice to have.

So any of those, when they are low in the channel and you can construct a nice, conservative spread around them, will do the trick towards building a dividend portfolio but use the REITs sparingly because they are a lot of risk for those 10% dividends – in the LTP they represent about a 10% allocation because it's nice money when it works – until it doesn't.  Also in the LTP, we almost never enter the REITs unless they have dropped about 40% and we think they have bottomed – because they often do (and will again).

These are not "sexy" trades, these are the slow, reliable trades that we put the bulk of our capital into while we allocate a smaller portion (generally around 20%) to more aggressive short-term trading BUT, even then, we use a lot of our short-term firepower to BALANCE out our long-term trades.  While the trades themselves are not sexy – our portfolio returns are VERY SEXY across the board – BECAUSE we use these techniques to Be the House – NOT the gambler and all those small wins add up over time with GREAT consistency.    

This year (2016), our Long-Term Portfolio has been 100% bullish and our Short-Term Portfolio has leaned bearish to protect it.  At the moment, we're playing for a correction over the summer, so we're not leaping into a lot of long-term positions, but that's a topic for another post…

For more content on Trading Education, check out our Archives at:  http://www.philstockworld.com/education/

 


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  64. According to a new Pew study, four out of five urban centers have seen household incomes shrink since 2000<p>Since the year 2000, more than 80 percent of metropolitan areas saw their household incomes decline, pointing to a shrinking middle class that’s fueling economic insecurity.<p>According to the Pew …


  65. Voters want change. Elites in D.C. and the media — both liberal and conservative — are actively obstructing it<p>As this wildly unpredictable primary season heads toward the finish line, the two frontrunners are widely seen as their respective party nominees. Given that presidential elections are …


  66. Hold on to your flower crowns. While the Coachella Valley Music Festival is perceived by some as the new Hippie Woodstock, it’s anything but. This …


  67. 1<p>The Double Burger with Cheese at Hard Times Sundaes<p>2<p>The Cheeseburger at Joe Jr.<p>3<p>Joe Jr.<p>4<p>The Chargrilled Burger at the Spotted Pig<p>5<p>The Hamburger at …


  68. The other day I made some comments to Rvn on the future growth of AAPL. Having daughts in my mind due to the small moat of AAPL, that the stock will still outperform. Here I am reading some more comments, reinforcing my thoughts. Phil, I am wondering if we are not banging a hole in the table with buy buy buy instead of bye bye bye!!!!

    Apple stock is still likely to continue underperforming, though the magnitude and probability are getting lower as we approach the iPhone 7 launch.

    From August until the iPhone 7 launch, Apple stock has a higher likelihood of outperforming, on account of hope building up into the launch.

    However, right after the launch, and if rumors that the iPhone 7 will use the 6/6s design are proven true, I expect further Apple underperformance. I expect it because it's highly likely that such an iPhone would have trouble getting a lot of traction in the market, since it would have an obviously outdated design.


  69. Phil/STX  Hi Phil. So STX is  one of my covered call positions.  I sold the May $32 calls when the stock was $34 and the earnings tanked it to $25. I bought back the callers, but didn't want to sell more calls "low in the channel", but I sold some $25 puts.  Too early!  STX tanked again to $19.  I am thinking of adding some Jan 17 long calls and selling monthly calls against them, leaving the stock naked to try to work back some of the loss.  Covered calls work great until the stock goes  down and I don't know whether to sell lower calls (and lock in some of my loss temporarily) or hang on naked looking for a bounce.  Your advice, please!


  70. Thanks for tutoring on cover calls etc.


  71. /cl spiking to 46.91!


  72. Last night, when previewing the most important macro event of the day – far more important than US retail sales which predictably tried to refute the …


  73. Ethiopia is in the middle of the worst drought in 50 years. It’s the sort of shock to the system we are likely to see more of with climate change. But Ethiopia is also home to a successful experiment to make the land more resilient to drought.<p>If we are going to adapt to our changing world, it’s …


  74. SINGAPORE (Reuters) – Gold rose for a second session on Monday, as slowing economic growth in China and weakness in Asian stock markets lifted the safe-haven appeal of the precious metal.<p>Spot gold gained 0.4 percent to $1,277.7 an ounce by 0244 GMT, while U.S. gold futures added 0.5 percent to …


  75. <i>The following comprehensive analysis of current market risks and concerns, represents one of the better summary assessments by both Brean Capital’s</i> …


  76. <b>Irreconcilable Positions</b><p>Greece owes the Troika over €11 billion in bailout repayments through the end of July. Greece is unable make those payments …


  77. Yahoo appears to be making progress in efforts to sell itself, despite some initial skepticism.<p>The latest piece of evidence: Among those vying for the company is the unusual combination of the investor Warren E. Buffett and Dan Gilbert, the founder of Quicken Loans and owner of the Cleveland …


  78. Saudi Arabia was downgraded by Moody’s, the US credit rating company, as low oil prices and falling economic growth begin to take their toll on the country’s finances.<p>Moody’s said “lower oil prices have led to a material deterioration in Saudi Arabia’s credit profile,” in a statement published on …


  79. <b>(CNN) —</b> Protests rocked the Venezuelan capital of Caracas Saturday, as rival factions of pro- and anti-government activists took to the street to add their voices to President Nicolas Maduro’s latest attempt to exert some control and hold onto power.<p>Addressing the nation Friday, Maduro declared a …


  80. Miami didn’t get a vote in the Brazilian Senate’s decision early Thursday morning to impeach President Dilma Rousseff, who was suspended from office and will face trial on accusations of financial mismanagement.<p>But the agonies of the vote, and the corruption scandal at large, have been felt and …


  81. Yen slips after initial rise on China growth worries

    The yen reversed course and eased versus the dollar on Monday, after rising initially as disappointing economic news out of China shored up demand for the safe-haven currency.<p>Chinese investment, factory output and retail sales all missed forecasts, adding to doubts about whether the economy is …


  82. U.S. inflation and industrial production releases are also on the calendar<p>U.S. data and minutes from the Federal Reserve will provide clues on inflation and on how fast the central bank may rev up rates this year. And finance ministers from the Group of Seven largest industrialized nations will …


  83. <b>Japanese stock markets rose in early trade, shrugging off disappointing economic data released by China over the weekend.</b><p>The Nikkei 225 index rose 0.4%, while the broader Topix gained 0.1%.<p>China’s industrial output, retail sales and fixed asset investment all grew more slowly than expected in …


  84. Berkshire Hathaway <b></b>held its annual meeting recently and released its first quarter report this past Friday, so there is no better time to examine the factors that have contributed to the uncommon success of Warren Buffett’s conglomerate.<p>Buffett watchers will often point to Berkshire’s unique …


  85. Donald Trump and Hillary Clinton promise to rejuvenate the nation’s economy. Meanwhile, the process of electing one of them to the presidency will likely bruise it.<p>The two leading presidential candidates, who sit far apart on the ideological spectrum, have prescribed either divergent or vague plans …


  86. Expectations are growing that Japanese currency authorities may intervene in the currency market after they explicitly warned they would do so, worried that the yen’s rise to its highest levels in a year and a half will threaten the already sluggish economy.<p>Japan’s currency intervention tends to …


  87. Combined with lower than expected growth, both oil-linked contract prices and spot prices have plummeted and narrowed the price differentials between the three major markets: the Americas, Europe, and Asia. Per WoodMac, <b>“Up to half of US LNG at risk of shut-in over next 5 years.”</b> All businesses must …


  88. SINGAPORE (Reuters) – Oil prices edged up in early trading on Monday as output falls in Nigeria and worries about political instability in Venezuela tightened the market, although rising OPEC output and a stronger dollar capped gains.<p>International Brent crude futures <LCOc1> were trading at $48.11 …


  89. China couldn’t get enough copper in 2005. Copper is vital for industries ranging from manufacturing to telecommunications and China was the world’s manufacturing hotspot at the time. So it needed a lot of copper. But some in China were willing to bet money that copper prices were about to fall.<p>At …


  90. The criticism is the latest volley in an escalating, election-year fight over the Benghazi panel’s actions — or inaction<p>(WASHINGTON) — The House Benghazi committee’s Republican chairman is ignoring statements by his own former lawyer indicating that the U.S. military acted properly on the night of …


  91. <i>LONDON (Reuters)</i> — Google faces a record antitrust fine of around 3 billion euros ($3.4 billion) from the European Commission in the coming weeks, British newspaper The Sunday Telegraph said.<p>The European Union has accused Google of promoting its shopping service in Internet searches at the expense …


  92. Plenty of investors judge a stock’s dividend by one thing: the current yield. It’s a key figure, to be sure, but it’s just a starting point. If you’re investing for the long haul, dividend <i>growth</i> is way more important.<p>To see how focusing solely on current yield distorts the payout picture, take a …


  93. Orwell Does Cato

    David Glasner has an interesting post about how the Cato Institute suppressed an old paper of his, refusing either to publish it or release it for publication elsewhere, not for a few months, but for decades. What Glasner may not know or recall is that Cato has a long-standing habit of trying to …


  94. Flash’s death has been slow and painful, and now Google is planning to deal it another blow. Google has detailed plans to start blocking most Flash content with Chrome, with the change targeted toward the end of this year.<p>Under its current vision, nearly every website would have Flash content …


  95. Gaming revenues stumbled in March, but Boyd Gaming rolled the dice anyway buying up the Aliante Hotel & Casino in North Las Vegas.<p>At first glance this doesn’t look to be an optimal time to invest in casino expansion in Las Vegas. Gaming revenue all across Nevada was down 3% in March, the latest …


  96. Over the last 15 years, the real estate market for first-time homebuyers has been fairly strong. Before the financial crisis, lending standards were such that first-time buyers had little problem obtaining the financing they needed to move into a home of their own. After the crisis, the Obama …


  97. Shaky hands in Apple (NASDAQ:AAPL) in Q1 may have been selling to The Oracle as Berkshire Hathaway (BRK.A, BRK.B) shows a new 9.8M share stake in company.

    AAPL +1.9% premarket