Using Stock Options to Pay Yourself 2% Monthly Dividends

by Phil

Sometimes we forget the basics.
In our video series, there’s a lesson called “The Secret to Consistent 20-40% Annual Returns on Stocks” and I hope you’ve seen it.  Although the low implied volatility of the market has made it a rough year for option selling, we were still able to scratch out just over 40% profits in four months in our paired Long-Term and Short-Term Portfolios.    Our other virtual portfolios are also performing very well with the Options Opportunity Portfolio up over 100% in 2016 and, surprisingly, our very conservative Butterfly Portfolio is up over 60% due to some not very conservative bullish adjustments we made in the February dip.  On the whole, though, we accomplished all this by following the BASIC strategies we teach at Philstockworld, not by gambling! 
I’ve written this article before, the first draft was on May 14th of 2016 so let’s start by showing you how our picks from that article did so MAYBE you will take the rest of what we have to teach you seriously – time is money and, at PSW – we don’t waste either!

Trade Idea #1 was Barrick Gold (ABX) using the following combination:

  • Buy 1,000 shares of ABX for $18.40 ($18,400)
  • Sell 10 June $18 calls for $1.40 ($1,400)

In this case, ABX was at $20.11 on June 17th and the stock was called away for $18  ($18,000) so the profit was $1 ($1,000, as you keep the short call money too).  While making $1,000 an outlay of $17,000 (5.8%) is not that sexy, keep in mind this was 34 days later – that’s your MONTHLY dividend, as advertised.

Trade Idea #2 was Ford Motors (F) using the following combination:

  • Sell 1 F 2018 $12 put for $1.50 ($150)

The idea of that trade was to collect the $1.50 and only buy F at net $10.50 if it went lower.  It didn’t and the short puts are currently priced at $1.15 ($115) so they are up $35 (23%) in 8 months.   Obviously, you don’t have to do one contract – it was just an example but you CAN do one contract and making over 23% a year in a small portfolio with low risk is a great way to start small.

Trade Idea #3 was Pfizer (PFE) using the following combination:

  • Buy 500 shares of PFE for $32.61 ($16,305)
  • Sell 5 2018 $30 calls for $4.20 ($2,100)
  • Sell 5 2018 $28 puts for $2.20 ($1,100)

In this case we were in it for the dividends and PFE paid 0.30 per share ($150) on Aug 3rd and Nov 8th so far – that’s $300!  Meanwhile, the stock is now down at $31.42 ($15,710) but the $30 calls we sold have dropped to $2.70 ($1,350) and the $28 puts we sold have fallen to $1.28 ($640) so EVEN THOUGH PFE HAS LOST $1.19 (3.6%) in 8 months, our net $13,105 entry is now net $13,720 plus the $300 dividend is $14,020 for a $915 profit (7%) so far.
Do you want to learn how to make 7% on stocks that drop 3.6%?  Then read on!
These are conservative picks that get good, solid returns.  Certainly we are not adverse to gambling, gambling is fun – but fun means fun, which means it’s a small part of our total investing portfolio while the vast bulk of our money is SENSIBLY INVESTED in safer strategies that are designed to grind out consistently good returns over many years.
We have discussed the long-term advantages of compounding annual growth in “How to Get Rich Slowly” and now we’ll begin discussing some basic strategies that will help you generate those consistent annual returns to put you on a path to a healthy, wealthy retirement.
In the “7 Steps” video, we’re discussing a basic covered call strategy and we delve into the Fundamentals of stock selection.  At the time (Sept 2013), we were using ABX, which was trading at $19.15 and we sold the November $19 calls (45 days out) for $1.30.  The simple instructions were to wash, rinse and repeat to make up to 40% a year by simply selling calls against the stock.

As you can see, ABX has dropped as low as $6.57 since then, down about 65% BUT, had you followed through and kept selling calls, we had a lovely 12-month period in which it stayed in our range and that would have given us 8 opportunities to collect at least $1 for $8 back before the stock turned down in September of 2014.  That would have dropped the net outlay below $10 and stopping out at $15 would have been a 50% gain for the year – even as the stock dropped 22% (from $19.15 to $15).

Even if we stuck with the stock as it kept going lower, there were 15 more months of flat or dropping action in which, even if we collected just 0.50 per month, it’s another $7.50 off our basis, bringing it down below $2.50 and eventually stopping out at $7 would be a 180% gain – despite the stock going 65% in the wrong direction!  Now are you interested in learning more about this “boring” system?

You can’t get more basic than this – just mindlessly selling covered calls every month or two and, even when the stock ends up being a dog – 180% returns!  There’s nothing fancy here other than our selection of a range-bound stock which, of course, we stop playing when it falls out of our range.
ANYONE can learn how to trade this way (and we go over all the strategies in our book, of course) yet, unfortunately, a lot of traders tend to FORGET how EASY it is to make money by just sticking to the basics.
As with the Dark Side, it is easy to be seduced by the allure of quick and “easy” money using options for leverage and trying to beat the market for a big win based on some “tip” you got, be it from a friend or a guy on TV or even someone like me.  THAT’S GAMBLING!!!
Never forget that that’s gambling and you will be OK.  Gambling is NOT investing.  Investing is what we should be doing with the vast bulk of our equity assets – gambling is not!  See our series on Smart Portfolio Management, which has examples for $10,000, $100,000 and $1M+ portfolios.  We demonstrate a lot of these trades for our Members during the year using 4 virtual portfolios with various sizes and trading styles.
BUT, as I said above, sometimes we just forget the basics – the reason we love options in the first place.  We can sell a put to give ourselves a discounted entry on a stock and we can sell a call to pay ourselves a dividend.  Year after year we demonstrate how these techniques can give you those consistent 20-40% annual returns WITHOUT taking huge risks and this coming year, our concentration is going to be on having our Members EMBRACE those long-term wealth building strategies.

If you believe investing is gambling, then you are doing it wrong and, if you believe investing is gambling – you are more likely to take the kind of risks that ARE gambling, which will then reinforce your misguided view that investing is gambling – get it?

There is no gambling in buying 500 shares of ABX TODAY, for $17.79 ($8,895) and selling 5 2019 $15 calls for $5.70 ($2,850) and $15 puts for $2.40 ($1,200).  Your net entry is $9.69 ($4,875) and, on Jan 18th, 2019 (720 days), you will either be called away at $15 with a $5.31 profit (54.7%) if the stock is above $15 or, if ABX is below $15, you will be assigned another 500 shares at $15 ($7,500) leaving you with 1,000 shares at $12.375, which is 30% below the current price.  Owning the stock for a 30% discount is your worst case!
This is not an options class so I won’t get into all the what-ifs down the road.  Suffice to say you can repeat the performance that gave us eventual profits on ABX in the past with very little risk.  Now, our Members know there are fancier ways to go, so let’s pick another example and see if we can make it more interesting than 54.7% in 23 months (2.37%/month).
Remember, we want to find stocks that are likely to stay in a channel.  Stocks that have decent volatility day to day (to boost the price of the options we sell) but are not too likely to stray from a trading range of maybe 20% up or down.  WMT comes to mind, MCD, VZ, T, F…  Blue chips are good when you are beginning, as they are less likely to go to zero.
I still like Ford, because F is only $12.49 a share so anyone can play with it.  Option contracts trade in 100-share blocks so SELLING 10 of the 2019 $12 put for $1.92 ($1,920) obligates you to buy 1,000 shares of F for $12 ($12,000) and puts $1,920 in your pocket right away.  That nets you into the stock for $10.08, which is giving yourself a quick 19.3% discount (see “How to Buy a Stock for a 15-20% Discount).
You can then conservatively buy 1,000 shares the stock for $12.49 ($12,490) as well and that would put you in at a net of $10.57 a share and, if F goes below $12 and the 1,000 shares are assigned to you from the short puts, then you end up with 2,000 shares at an average of $11.285 ($22,570) – that’s your maximum risk on the trade (and F is not likely to go to zero, of course).  Now you can sell 10 2019 $12 calls for $1.80, putting another $1,800 in your pocket, so the total cash outlay drops to $8,780
If you are called away in Jan, 2019 at $12, you get paid $12,000 in cash, keep the $1,920 from selling the calls and the $1,800 from selling the puts.  That would be a profit of $3,230, which is 36.7% of our cash outlay.  Ford also pays a 0.20 quarterly dividend but we just missed Jan (18th) but 7 more $200 payments is a bonus $1,400 which pumps our return up to 52.7%, that’s 2.7% per month!
And, don’t forget, in the worst case, you end up with 2,000 shares at $22,570, which is $11.285/share and then the 0.80 annual dividend is 7% alone and, of course, we’d sell 20 more calls (not puts unless you want 4,000 shares) for $1.80 ($3,600) and suddenly you have 2,000 shares at net $9.485 collecting your 0.20 quarterly dividends – that’s 2% per quarter on dividends alone!  Why does anyone put money in a bank?
As I often say to our Members, these are NOT magic beans – there is some risk, BUT – by intelligently managing our risk, we have a much more likely upside than downside and MOST of the time, we can make some very nice returns.
Now, there’s a fancier way to play F and that’s what we call an ARTIFICIAL buy/write where, instead of owning the stock (which pays a nice 4.85%, 0.80 dividend, we instead buy 10 2019 $10 ($2.98)/12 ($1.80) bull call spread for $1.18, selling the same $12 puts for $1.92.  That gives you a net credit on the spread of 0.74 ($740) and we’re only obligated to buy 1,000 shares for net $12 ($12,000) and you will get back $2,000 in the spread if F simply holds $12 into Jan, 2019.  The stock does not have to go up for you to make money!
On the downside, the worst that can happen is you end up owning 1,000 shares of F for net $11.26 – a 10% discount to the current price.  Given we have such a nice position, we can still sell calls to make even more money.  Since our cash outlay is a 0.74 credit and margin required is $1.44 per contract, our goal should be just to collect 10% per month of the 0.70 cash+margin we’ve committed to the trade – otherwise we are engaging in the great sins of greed and over-leveraging.
Looking to make 0.07 per month is easy.  We can, for example, sell 5 March $13 calls for 0.15 ($75) and see how that goes before selling more.  That’s a very easy way to quickly generate 10% monthly returns while your upside risk doesn’t kick in until F is over $13.15, well over the top of your spread (otherwise you just roll your short calls along on months you don’t collect the cash).

Again, not magic beans – some months you will win and some you will lose but, on the whole, when the potential is to make 120% per year if you have 12 winners – there’s a HELL of a lot of ways you can end up making 20-40% returns with little trouble.

As a rule of thumb, if a stock isn’t paying 3.5% or better dividend, there’s no point in tying up the cash required to own it – so we’ll prefer the artificial buy/write to the traditional but both are valid and both are very powerful long-term wealth creation tools that form the basis of our Long-Term Portfolio.
Here’s a great list of Top Dividend Stocks by Sector and Coke (KO) is on sale and pays a $1.40 (3.35%) dividend which, of course, we can enhance using our system.

  • Buy 6 KO 2019 $35 calls for $7.50 ($4,500)
  • Sell 6 KO 2019 $42 calls for $2.90 ($1,740)
  • Sell 4 KO 2019 $38 puts for $2.85 ($1,140)
  • Sell 3 KO April $42 calls for $0.67 ($201)

Our net entry here is just $1,419 on the $4,200 spread so the upside potential here is $2,781 (196%) plus whatever other short calls we sell along the way.  The net ordinary margin on the short puts is $1,948 and, of course, we’re obligated to own 400 shares of KO at $38 ($15,200) plus the $1,419 we lay out works out to an average of $41.55 if assigned so no discount but a much smaller assignment risk this way.
These are not “sexy” trades, these are the slow, reliable trades that we put the bulk of our capital into while we allocate a smaller portion (generally around 20%) to more aggressive short-term trading BUT, even then, we use a lot of our short-term firepower to BALANCE out our long-term trades.  While the trades themselves are not sexy – our portfolio returns are VERY SEXY across the board – BECAUSE we use these techniques to Be the House – NOT the gambler and all those small wins add up over time with GREAT consistency.
Last year (2016), our Long-Term Portfolio has been 100% bullish and our Short-Term Portfolio has leaned bearish to protect it.  At the moment, we’re playing for a correction that, so far, has never come so we’re not leaping into a lot of long-term positions, but that’s a topic for another post…

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