Boost Your Dividend Yields With This Strategy

Most of the large-cap stocks you own aren't going to double. You're probably just holding onto them for their dividends. That's why they're perfect for the strategy I'd like to share with you today.

This approach could help you eke out a few extra percentage points in yield, in addition to the dividend yield you're already receiving. If you master the strategy, you might even be able to pocket an additional 15% to 20% per year in additional income.

How is this even possible?
You can add some extra yield to your large-cap positions with options.

The conservative options strategy I'm referring to here is covered calls. In this approach, you own shares of an underlying stock (since options are based on 100 underlying shares, you should own 100 for every option you write), then write a "sell to open" contract.

When you write this contract, you'll agree to sell the underlying stock at a set price if it reaches that level by a certain date. Then you're paid a premium.

For example, say a large cap you own 100 shares of is trading around $56, and you'd be happy selling for $60 a share.

You could write one covered call on this position, agreeing to sell those 100 shares a few months out for $60 each. In exchange for this deal, the option buyer will pay you $1.50 per share, for a total of $150.

The expiration date rolls around, and the stock is still hovering around $56 per share, which means you pocket the $150 as pure profit -- a yield of 2.6% in just months -- and then repeat the process, writing another covered call on the position.

It's that easy
Of course, there's risk in this equation. If the stock soars well above $60, you'll miss out on those additional gains. But if you can find companies that trade in a typical range, and which you're happy to sell should they reach a certain price, this strategy is perfect.

Here are a few companies that traded in a stable range over the past year, and which could be smart choices for employing covered calls:

Company

52-Week Range

Dividend Yield

Potential Call Option and Current Premium

Potential Covered Call Yield

Colgate-Palmolive (NYSE: CL  ) $73.12-$87.58 2.7% $87.50 Aug. Calls; $1.59 per share 1.9%
Eli Lilly (NYSE: LLY  ) $32.82-$39.40 5.3% $39 Oct. Calls; $0.73 per share 2.0%
Merck (NYSE: MRK  ) $31.06-$37.68 4.3% $37 Oct. Calls; $0.69 per share 2.0%
Johnson & Johnson (NYSE: JNJ  ) $56.86-$67.87 3.4% $70 Oct. Calls; $0.63 per share 1.0%
Procter & Gamble (NYSE: PG  ) $58.92-$67.72 3.2% $67.50 Oct. Calls; $0.60 per share 1.0%
Wal-Mart (NYSE: WMT  ) $47.77-$57.90 2.8% $55 Sept. Calls; $0.55 per share 1.1%
Microsoft (Nasdaq: MSFT  ) $22.73-$29.46 2.7% $25 Aug. Calls; $0.41 per share 1.7%

Source: Yahoo! Finance.

As you can see, some of the covered calls yield a significant chunk of the entire annual dividend -- over a period of just a few months.

Of course, as I mentioned earlier, there is some risk to this strategy. You could be forced to sell your shares at the determined price. But if you're bearish on the market (which seems to be a wise outlook), this could be a great way to add a steady stream of cash to your portfolio.

But this isn't the only use for options
You can also gain an income stream from your portfolio by writing puts. This gives you the ability to buy a stock you're interested in at a price below where it currently trades.

But if the stock doesn't fall to that price, you similarly pocket the cash. Jeff Fischer and Jim Gillies, our Motley Fool options experts, call this "a favorite strategy to seed a portfolio."

If you're interested in more information on this strategy, along with other ways to use options right now, I invite you to check out the video seminar and options trading guide, "The Motley Fool 'Options Insider' Playbook," these two options traders just finished putting together.

For a limited time, both are completely free -- despite the fact that many investors have shelled out nearly $1,000 to see the same content. Simply drop your email address in the box below for more information.

Adam J. Wiederman owns no shares of the companies mentioned above. The Motley Fool owns shares of Wal-Mart Stores, Microsoft, and Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of Wal-Mart Stores, Procter & Gamble, Microsoft, and Johnson & Johnson. Motley Fool newsletter services have recommended creating diagonal call positions in Wal-Mart Stores, Johnson & Johnson, and Microsoft. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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