I understand the process of finding suitable dividend stocks can be downright exhausting.
After all, screening for companies with high recurring revenue streams, low debt to equity ratios, high free cash flow, a history of increasing dividends (among other fundamental traits) and an attractive yield takes time.
That’s why we’re here to help, of course. But that’s beside the point.
What worries me is the conventional wisdom that says our work is done once we (finally) find an attractive dividend stock. That’s dead wrong!
Dividend investing isn’t a “select it and forget it” type strategy. Not if we want to maximize our income. And who doesn’t want to do that?
So, today I’m going to share with you the most overlooked way to boost your income on a dividend stock. Sure, it requires a little extra work. But it’s a simple and safe strategy to generate extra income and easily double our yield (or more) on dividend stocks. Even ones we already own.
Rest assured, I’m not the only one keen on this strategy.
The Wall Street Journal pointed out this is “an attractive trade in a sluggish market” to “generate income.” And The Financial Times agrees, saying this strategy “works best… in falling markets.”
In other words, there’s never a bad time to implement this strategy.
Best of all, we can put it to work immediately. So let’s get to it…
Covered Calls: The Secret to Maximizing Income
While working for one of the world’s biggest banks, helping manage over $1 billion in retirement funds, I witnessed all kinds of ways to make money through the stock market. One method quickly became my favorite, though. And that’s writing covered calls.
Yes, it’s an options strategy. But before you go running for the hills, afraid all options strategies are risky, let me assure you that’s simply not the case here.
Truth is, writing covered calls is the most conservative options strategy out there.
That’s why professional investors have been using it for decades to increase income. That’s why the U.S. government even allows it in retirement accounts. And if you’re serious about safely maximizing your income, that’s why you need to start using it, too.
So before we do anything else, let’s make sure you understand how to write covered calls. Then we’ll cover how we take the income potential to the next level.
The Anatomy of a Covered Call
The basic goal of a covered call is to create income and reduce risk. In exchange, you give up some of the potential upside on your holdings. While that might sound complicated, executing a covered call trade isn’t complicated at all.
In fact, it isn’t much different than simply buying and selling stocks. Carrying out the trade can be accomplished just as quickly with an online brokerage account and a few mouse clicks.
Here’s how it works:
- Step 1: Buy a dividend-paying stock and wait for the order to be filled.
- Step 2: Write one covered call for every 100 shares you own and collect the option premium as income. All you have to do is enter the specific call option symbol you’d like to sell as a “Sell to Open” transaction. (This means you’re opening a new position by selling/writing a contract. If you close the option before expiration then use a “Buy to Close” transaction.)
- Step 3: Wait for the option to expire, collecting any dividends along the way.
- Step 4: If the option expires worthless, write another covered call, collecting even more premium and dividend income.
The Income-Boosting Power of Multiple Premiums
It’s important to realize that the aim of writing covered calls isn’t to produce home-run-type profits. Instead, it’s to chalk up consistent profits of 1% to 3% per trade. While that might not sound like a lot, it adds up.
You see, anywhere from 70% to 90% of options expire worthless, depending on the source of the research. So once a call option expires, we’re free to write another covered call against our stock position to collect even more income. And as long as the stock doesn’t move too high too fast, there’s no limit to the number of times we can collect this income.
That’s the magic of multiple premiums and what makes writing covered calls so profitable over time.
Just consider: If you own a stock yielding 4% and write covered calls against your position three times over the course of the year for an average premium of 2%, your yield jumps to 10%. In other words, you’ve more than doubled your yield.
Bottom line: There’s no reason to stop “working” once we find a compelling dividend-paying stock. Not if we want to maximize our income. And there’s no safer and simpler way to do that than by writing covered calls. So stop overlooking this simple strategy and start using it today!