How Options Can Often Double or Triple Your Dividend Income

With good yields hard to find, this strategy can be an income investor’s best friend. This IRA-friendly income strategy targets an annual yield of at least 12%, PLUS you can get the regular dividend payment on top. Better still, using this options strategy can be LESS RISKY than owning shares alone. Ron and Bro sit down with Motley Fool Options co-advisor Jeff Fischer to discuss the ins and outs of this essential income investing strategy.

 

View the transcript of this video.

Total Income Special Report: Covered Calls

Before I tell you how one of the easiest (and safest) options strategies can dramatically increase the income you earn from stocks you already own, let me share the three things I think prove that options investing done the Motley Fool way, when used alongside your existing portfolio, is superior to any wealth-building strategy you've seen or tried before:

  1. We've figured out a way to take the world's most powerful financial tools and instruments (options) and make them simple to use — as you'll discover in just a moment…
  2. Since 2005, our public options recommendations have made money more than 90% of the time. It's true: Since The Motley Fool began issuing public options recommendations in 2009, our combined win rate for closed options recommendations is 93.1%…
  3. A special edge — we only recommend options investments on stocks from our existing Foolish universe… In other words, stocks you already know and love, fully vetted by The Motley Fool's best analysts and advisors…

But if you're anything like me — skeptical as well as optimistic — you might be wondering: Is this approach really different? Is it really better?

So let me prove it to you right now… Showing you how we recommended to members to pick up a 7.5% yield (in just over four months) on a stock that doesn't even pay a dividend…

And even turned a slow-growing cash cow business into a 37% gain… And collected a 40% cash bonus on a "boring” retail business.

We're making all of this available to you today for FREE as part of a special introduction to our newest investing service: Motley Fool Total Income.

Two simple steps to multiplying your portfolio income

How we earned a 7.5% yield in just a little over four months on a stock that doesn't even pay a dividend …

In scenario #1, the stock finishes below the strike price.

Meaning that the calls you sold will expire worthless, and you get to keep all the income you collected at the beginning — regardless of what subsequently happens to the stock.

Take our recommendation that Options members write covered calls on Proto Labs (NASDAQ: PRLB), the rapid prototype manufacturing leader you might recognize as a pick from David Gardner's Rule Breakers service (it's also a real-money pick in Motley Fool Supernova and MDP).

In May 2015, with Proto Labs' shares trading at $69.70, we recommended that members sell the $70 calls expiring in two months, which members were able to do for $3.09. That's better than a 4.4% yield in a mere two months.

Fast-forward to expiration… the stock was down only slightly, closing at $69.15. Because this was below the $70 strike price, the sold calls expired worthless. Members were left with both their shares and the $3.09 in cash.

Meaning that we could recommend another covered call for additional income. Which is exactly what we did — recommending that Options members sell the August $70 calls to collect an additional $2.19, bringing the total to an impressive $5.28 per share in income on a stock trading for about $70 — in just a little over three months!

In other words, Options members earned $528 just for owning Proto Labs… a widely recommended Fool stock!

It's a prime example of how you can boost the Foolish investing you already do — earning more cash and building your wealth faster than ever before.

Back to the well in Proto Labs for another 9.6 yield%!

In scenario #2, the stock finishes above the strike price, and you do nothing.

Your shares get "called away,” which just means that they will be sold at the strike price of your sold call, regardless of where the stock is currently.

Let's consider Proto Labs again… By the time the options expiration rolled around in August, the stock was trading above the $70 strike price.

Now, you don't always have to let your shares get called away (more on this in a moment), but in this instance, we recommended members do exactly that in order to lock in their profits. This meant that members sold their shares for $70 even though the stock closed at $72.35.

You might be thinking that members got the short end of the stick, considering they had to sell the stock for less than it was trading for at the time, but I bet that if you took a poll of our members, you'd find that they were very happy with the outcome…

Remember: The Proto Labs position began in April of that year with a put write. After those puts became shares, members then wrote the two covered calls we just talked about.

Their total return during the four months the position was open? A very respectable 9.6%. Especially when you consider the S&P 500 fell by 6.4% over the same time frame and Proto Labs' stock fell by 7.4%!

How we earned a 40% cash-on-cash return from a boring retailer

In scenario #3, the stock is currently trading above the strike price of your call, but instead of letting the call get exercised (Outcome #2), you "roll” the position — which means you repurchase the calls you originally sold while selling new calls with an expiration date that is further out ("rolling out"), with a higher strike price ("rolling up"), or with both ("rolling up and out").

We first recommended writing covered calls on GameStop in early February 2010.

By this point the post-financial crisis rally was solidly under way… and yet shares of the brick-and-mortar video game retailer were setting new 52-week lows.

Why? Because concerns about digital downloading made some investors think of GameStop as a dead man walking… But we had done our homework. We saw a company with a great management team, still generating lots of cash, and with a fairly valued stock.

In other words, a great opportunity to generate cash income and possible capital gains by writing covered calls!

With the stock trading at slightly over $20, we recommended members sell the April 2010 $21 calls, collecting $1.10 per share in income.

As expiration approached, GameStop's stock rose above $21, ensuring that members' covered calls would be exercised – if no follow-up action was taken.

As we noted in a subsequent trade alert, the company's better-than-expected financial results and aggressive share repurchases now meant the stock was more valuable. Doing nothing – letting the shares get called away – would be leaving money on the table.

And that's not what we're about at Options.

So Jim recommended that members roll their April covered calls up and out to the July $23 calls. And when those calls expired worthless, members wrote new calls on GameStop. And when this next round of calls looked like they were at risk of being exercised, members rolled their position up and out yet again…

All told, this one position on GameStop lasted in excess of two years, with members rolling their covered calls on multiple occasions.

The net result was a total of $8.21 in income per share on a stock that initially cost members $20.25…

Making for a full 42.5% gain that outperformed simple long stock ownership by 22.3%!

CHART OF GAMESTOP TRADES VS. LONG OWNERSHIP

The Risks

The risk of covered calls is the same as stock ownership, minus the premiums you've earned from selling calls. In other words, covered calls are actually less risky than owning shares outright because the options premiums you earn along the way offset potential drops in the stock price. Again, that's one reason they're so popular among retirees who are more interested in income than capital gains.

The big trade-off with covered calls is that you're capping your stock's upside at the strike price while still being exposed to its full downside potential. That's why we like to sell covered calls on stable stocks that we don't expect to rise or fall rapidly. You don't want to cap your upside on a fast-moving growth stock.

Finally, covering shares can be a great way to get paid for selling shares at higher prices, but if you're worried about one of your stocks falling precipitously, just sell the shares directly.

It's time to stop chasing pitiful yields and start collecting more income!

I trust by now you're beginning to see why so many conservative, income-focused investors are flocking to options. Because they're one of the safest ways to generate steady income, particularly in this low-interest-paying environment…

And that's what the 2017 Income Playbook is all about. It's designed to teach you how to turn your portfolio into an income-producing machine.

And please remember, we've made this Income Playbook freely available to you as a way to demonstrate the value of our newest service, Motley Fool Total Income, ahead of its grand opening to members.

If you've ever wanted to earn more income from your portfolio, this is an offer you won't want to miss.

All you have to do is watch your email inbox for all the latest announcements and events over the next several days.

Motley Fool performance as of February 8, 2017