This article is part of our series on options investing, in which The Motley Fool is sharing a number of strategies you can use to get better results from your investment portfolio.
Lately, dividend stocks have captured the attention of investors everywhere. With turbulent markets and an uncertain outlook for the economy, you want tangible proof that your investments are working hard for you -- and there's nothing more tangible than cold hard cash in hand.
Unfortunately, not all companies see fit to return capital to their shareholders via dividends. But with a simple strategy involving options, you can draw income even from stocks that don't pay dividends -- without having to sell shares at current prices.
Getting what you need
Many companies that choose not to pay dividends have perfectly legitimate alternative uses for their spare cash. Some companies use share buybacks, which can boost the stock price by improving earnings per share. Others simply plow most of their free cash flow back into their business, which can be a great strategy if a company can find better opportunities than you could with the cash.
Yet even when companies make smart moves with their capital, not paying dividends can hurt shareholders like you if you really want income from your stocks. That's where using options can help -- by giving you the income you need.
Spread out your options
Earlier in this series, I wrote about using the covered call strategy. By selling call options against shares you already own, you receive money up front. In exchange, you give the option buyer the right to buy your shares from you at the price you agree to. As long as the stock price doesn't rise above that specified strike price by the time the option expires, the option will expire worthless, and you'll get to keep the upfront premium as income.
For stocks that stay in relatively predictable ranges, covered calls work great. But the downside of the covered call strategy is that if the stock skyrockets, you're stuck having to sell your shares at a lower price to the option buyer. With growth stocks that don't pay dividends, those big jumps happen fairly frequently.
Because of that, I recommend a slightly different strategy for dividend-tightwad growth companies. Rather than just doing a covered call, writing a call spread involves selling one call option while buying another with a higher strike price. Doing so reduces your income somewhat, but it also limits your lost upside if the stock makes a really big move up.
Lots of cash but no dividend
To see how the strategy works, let's take a look at big companies with huge net cash positions that don't pay dividends and see how much income an example of a call spread strategy can generate:
Recent Share Price
Write This Option
Buy This Option
||548.50||December $575||December $600||8.10|
||402.19||December $425||December $450||7.15|
||16.24||January $17.50||January $20||0.60|
||236.81||January $275||January $300||4.31|
||38.89||December $42||December $45||0.79|
||32.75||January $36||January $40||1.02|
||27.55||January $32||January $35||0.62|
Sources: S&P Capital IQ, Yahoo! Finance. Option price based on midpoint of bid-ask spread at close.
Take NetApp as an example. With the shares trading near $39, you can write a December $42 call and buy a December $45 call and receive $0.79 per share in net income. If the shares stay below $42, then that money -- roughly 2% of the share price -- is net profit. If the stock goes above $42, then you'll either have to buy back the option you wrote or sell your shares for $42.
But if the stock makes a really big jump -- say to $50 -- then you'll be able to exercise the option you bought to participate in much of the upside. In this case, if shares went from $39 to $50, you'd end up with a net profit of almost $9. That's a big portion of what you would've earned just by holding the stock.
Get some income
From the numbers above, you can see that a call spread strategy can yield income of 1% to 4%, depending on how aggressive you are in setting your strike prices. Moreover, as long as you own shares, you can repeat the process each time your options expire.
Options may seem tricky, but they're really versatile tools. By turning non-dividend stocks into income producers, you can open up a whole world of possibilities.
Stay tuned throughout our options investing series and get the strategies you need to earn more from your investments. Click back to the series intro for links to the entire series.