Writing Covered Call Options Against High Dividend Yielders

The Income One-Two Punch

Part One

When approaching covered calls a lot of investors are going to view it in terms of a buy/write where the value of the underlying security and the potential of it going to zero is a substantial factor in your risk/reward however.  I however will not.  At this point I will assume that you have bought an underlying stock for its income potential or its dividend yield and although you give a nod to the underlying value, your main concern is whether the dividend is cut or not.  Thus, traditional methods of covered/call risk reward models (loss of value) do not necessarily apply to us.  Our concern is income.  Now, let’s create more of it.

So you have a stock.  Good for you.  And it is kicking off a decent dividend.  Say a yield of 10%.  Again, good for you.  With a $10,000 investment, you would get about $83 a month of passive cash flow.  Even better for you.  Now, let’s say you have a game plan to get out of the rat race.  You need to generate $2000 a month to hit your goal.  Your plan is to generate $1000 of it from dividend income and covered call writes.  (depending on how much time you spend researching your call writes your option premium income may not be passive.  Thus, you also need a goal to get really fast at researching and writing your covered call writes so you can spend more time hiking in the Grand Canyon.)  You decide to split the $1000 down the middle.  You will generate $500 a month from dividends and $500 a month from covered call writes.  Now, how much capital do you need?

The answer: 60,000 smack-a-roos.  This might seem like a lot but remember we are going to generate 1000 bucks a month from this capital for a 20% cash on cash return.  If you can find a better rate, say from a rental property, then go for it.  But why not diversify, buy a dividend stock, generate further income from writing covered call options against it and get a rental property.  I know this sounds like a lot but think of the tremendous asset diversification you have from this plan, the amount of income you can generate and the small debt load you have to carry in order to achieve this.  (yes, I know.  Debt provides you with leverage but if you are not really comfortable having tremendous amounts of debt, this might be the option for you.)  Why not shoot for generating $500 a piece from each of these assets; $500 dividends, $500 covered call writes and $500 rental?  If you do, I think you will be well on your way to truly diversified financial independence.   

Your Options are Limited but That Can Be a Good Thing

I say find the dividends first.  Let the dividends be empirical in this model.  Use the dividend screens and dividend research narratives I have provided to help you narrow your search.  Find a good healthy dividend payer first and then worry about the covered call option.

Now research the call option for the underlying security.  This is covered in Part Two.