How to Create a Dividend for These 7 Stocks

Rising uncertainty. Slowing growth. Historically high profit margins that will revert to the mean. These are just some of the reasons to believe that stocks will tread water -- at best -- for the rest of 2011 and into 2012. Dividends anchor a stock's valuation and provide investors with income, which makes it much easier to hunker down and wait out a sideways market. But what if your portfolio is weighted toward stocks that don't pay a dividend? In that case, there's a strategy that enables you to create an income return on any stock you own.

There's nothing complicated about this
One intriguing approach involves options. Before your eyes glaze over, I want to emphasize that there is nothing complicated about it. If you read the next few paragraphs, you will understand how to generate income on stocks that don't pay a dividend --without any additional investment.

To understand the strategy, you need to know a few terms first -- options lingo. Call options give their owner the right to buy a stock at a predetermined price (the "strike" price) on or before a set date (the "expiration date.") If you sell a call option, the amount you receive is the option "premium." If the buyer ends up exercising the option (we'll get to why that might occur), the option seller has the obligation to sell the stock at the strike price.

Meet the "covered call"
The strategy I'm referring is called a "covered call." It involves selling a call option on a stock you already own (that's why the call is "covered.") At expiration, two scenarios are possible:

• If the stock price is below the strike price, the option expires and is worthless. You end up ahead by the amount of premium you received. That premium is your "dividend."

Selling options isn't free money; you've sold someone a right that has value under certain circumstances. Those circumstances lead to the second scenario:

• If the stock price is above the strike price, the option will be exercised. You still keep the premium, but you must deliver your shares in exchange for the strike price.

Selling your shares isn't a problem, assuming you have chosen a strike price that provides you with what you consider to be a satisfactory return. Value-oriented investors can select a strike that corresponds to their estimate of the stock's fair value, for example -- a price at which they would typically sell the stock anyway.

Show me the money
The following table describes seven covered call trades on stocks that don't pay a dividend. The third column shows the yield on the stock position that the covered call generates. The last column shows the return you earn on the shares if they are called away -- over a period that is significantly shorter than a year (with a September expiration date, it's little more than three months.)

*Annualized. Source: Author's calculations based on data from Yahoo! Finance.

The numbers in this table suggest that a covered call strategy can generate a very respectable return over current prices, whatever the outcome. Hopefully, you're beginning to see that options aren't purely speculative instruments. In fact, covered calls are just one among several low-risk strategies Jeff Fischer recommends to Motley Fool Options members. If you don't believe you can make consistent profits from options, you should know that of the 30 completed trades recommended by the service at May 31, 29 of them were closed at a profit. That's a 97% success rate!

A risk-free step toward options success
If you want to know more about what option strategies could do for your portfolio, simply add your email address below, and you'll receive -- at no cost or obligation to you -- the 'Options Insider' playbook. You'll also get access to three videos in which Jeff discusses option strategies and a live, interactive Q&A session in which he'll be available to answer your questions -- along with the entire Motley Fool Options team. This should be an easy decision: What's the downside to learning about a new tool for your investor toolkit?