Get More From the Best Dividend Stocks

Like more and more folks, I love dividend stocks these days, especially in my IRA. Good dividend stocks are a great way to ensure some returns during uncertain times.

But the truth is, even high-yielding dividend stocks don't generally yield more than 7% or so. What if there was a way to boost your returns from your dividend stocks without taking tons of risk?

There is. Read on.

An options strategy for the rest of us
More and more investors are discovering options, but plenty of folks still feel like they should steer clear. But not all options strategies are risky or hard to understand. Writing covered calls, for instance, is a simple way to increase your returns on relatively stable stocks without exposing yourself to undue risks.

What's that mean? Simple: A call option gives the owner the right to buy a stock at a specific price by a specific time. And you can sell options in addition to buying them -- that's called writing an option. If you sell a call option while you own the underlying stock, we say that that option is covered.

In other words, when you write a covered call, you're selling someone the right to buy stock you own at a specific price by a specific date. In return, you get some money, and -- if the option expires unused, as most do -- you get to write another one in a few months.

It's not hard at all. Let's look at how it works.

Here's how it works -- and what the risks are
If you don't already own one, look for a dividend stock that hasn't been too volatile recently -- you want the price to be relatively stable for the duration of your option. Because you're going to own this stock -- hopefully for a long time -- you want to pick a good one. When I screen for dividend stocks to focus on, I look for stocks with high CAPS ratings -- at least four stars, a good quick proxy for fundamental strength -- and solid dividend yields, along with other factors.

In this case, I also looked for stocks with relatively low price volatility -- under 20% over the last year. Here's a selection:

Sources: Morningstar, Yahoo! Finance, and Motley Fool CAPS.

Obviously, you'd need to do more research before buying any of these. But for purposes of our example, suppose we settled on Altria, and bought 500 shares at $23.50. You can now write five calls -- each option covers 100 shares -- that give someone the right to buy the stock from you at $25 between now and mid-December. As I write this, you'd get paid about $0.25 per share for those calls, or about $125 for the 500 shares.

So what could happen? How much risk would there be? There are three possible outcomes:

• The stock takes off. Altria's share prize zooms past $25 at some point between now and mid-December, and the buyer of your calls decides to exercise them. Altria could be trading at $40 in December, but your profits would be limited to the $1.50 a share from the sale, plus the $0.25 a share from the sale of the calls, plus any dividends the company might pay between now and then. Not counting the dividends, that's still a nearly 7.5% return on a large-cap stock you held for less than four months -- nothing to sneeze at.
• The stock tanks. Even stocks that look solid and stable take big price hits from time to time -- just ask any BP shareholder. But you still made that $125, and you still own the stock -- and you can write a fresh set of calls in December.
• The stock's price stays fairly stable. Altria's price doesn't go over $25 for any length of time. You pocket the $125, you still hold the stock when the options expire, and you can write another set of calls for another chunk of change just in time for the holidays.

In other words, the key risk added by the options is the risk that you won't be able to fully participate in a sudden price jump -- but if you think that's a possibility, just choose another stock. (There is another risk, of sorts -- if the stock does take a big adverse hit, you can't sell it while you've got calls outstanding. That would result in naked calls, which is a bad idea even if your brokerage allows you to do it, which they may not. But in a pinch, you can buy back the calls and then sell the stock -- if the stock's really in trouble, you should be able to buy the calls for a lot less than your original selling price.)

But all that said, writing covered calls is a great way to boost your income on those "boring" dividend stocks you've got in your IRA. Want to learn more? Check out the Fool's options tutorial for a great in-depth look at options strategies for individual investors.

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