I was looking at my stock portfolio recently, looking to see when to expect my next dividend payment. I was also looking at my current covered call options to see when they would expire and potential new trades to make.
The analysis led me to ask myself a question…How much can I make with covered calls while waiting for my dividend pay date? I was looking at my holding of Nokia.
I’ll explain what led me to this question using Nokia (NOK) as a good example.
First, I’ll quickly explain my current investing strategy. I buy dividend paying stocks in lots of 100 shares, when able. I then sell covered call options on those stocks.
The covered calls have strike prices that are at the money or just out of the money, meaning that I leave room for the stock price to appreciate.
The goal of this strategy is to gain income, seeking to have the stock called away at a higher price than my purchase price. While I wait for that potential to happen, I collect option premiums and dividends. Collecting that extra income while waiting for the option contract to expire effectively reduces the cost basis of the stock purchase and increases my gains.
Buying NOK and Selling Covered Calls
So, now we will look at buying NOK as an example. NOK is only trading at about $5.50 today and pays a dividend with a yield of about 5%, making this stock good for me and my small stock account. Note that this is also a stock I would not mind holding for a long term, if it played out that way.
Here are the initial transactions I made:
6/27/16 – Bought 200 shares of NOK at $5.14
6/28/16 – Sold to Open 1 contract NOK SEP 16 2016 6.00 C at $0.13
6/28/16 – Sold to Open 1 contract NOK OCT 21 2016 6.00 C at $0.14
Commissions took a big chunk out of my option contracts. I paid commissions of $7 for the stock transaction and $7.70 for each option contract. That means I was only able to collect $5.30 and $6.30 on the option contracts, respectively, for a total of $11.60 in option premiums.
That’s not bad, but it’s nothing to write home about. But it got me thinking some more. I said to myself, what if I sell one covered call per month and the stock never hits my strike price? Would that add up to something significant?
Dividends for NOK
The dividend on NOK was at about 5% when I purchased the stock. It now stands at 5.27%. The payout is in July, but I missed that cutoff by a few weeks (cutoff was early June).
I wasn’t worried about missing the dividend payout date…until I remembered that NOK only pays their dividend annually. Oops! That means I would have to wait a full year before seeing any dividends and would have to hold the stock that long.
My strategy doesn’t lend itself to long term holding, necessarily, so I was bummed out. But I could hold a stock long term if the price continues to stay below my option strike prices.
At 200 shares of NOK, I’m looking at collecting dividends of $0.2896 per share, or a total of $57.92. That’s not bad for just over $1,000 of investment.
Dividends vs. Options
Once I realized the stock only pays dividends annually, I started crunching some numbers to compare the dividend and the covered call options. I really dug into that question about how much I could make in option premiums for the year.
For this discussion, let’s stick with 200 shares of NOK and assume a holding period of at least one year. Let’s also assume that I sell a new covered call every month at $0.13 for the one year period and the stock doesn’t get called away (stock price never goes above my strike price of $6.00 at expiration).
That gives a total dividend of $57.92 for the year, or $4.83 per month.
That also gives total option premiums of $63.60 for the year, or $5.30 per month.
The result of the number crunching shows that even though the option premiums look small, they are slightly better than the current dividend.
If I stick with my assumptions, then I can collect a total of $121.52 (dividends plus option premiums) for the year, for a total return on investment (ROI) of 11.74%.
ROI: $121.52 / $1,035.00 = 11.74%
*The total investment was $1,035 for 200 shares of NOK, including commissions.
That ain’t too shabby for a small stock position with monthly option trades. I double my ROI by making the monthly option trades. And the covered calls are setup so that I have one contract expiring each month, which is a nice convenience.
Now, this also assumes that the stock price goes basically nowhere, staying roughly between $5.15 and $5.85, which is what it has done now since June. Dividend paying stocks tend to be more stable, more conservative, and long term based companies. That lends itself to slower moving stock prices.
Bottom line: I can potentially double my returns by using covered calls on my stock position with NOK.
This won’t hold true for all of my dividend stocks, but it works out for this one. And if my stock positions should get called away when the price reaches or exceeds my option strike price at expiration, I have built in a nice profit so I can collect income there as well.
If the stock gets called away, I will earn $135.60 when it sells at $6.00 per share (my option strike price) with a 13.1% return (before dividends or option premiums). That’s a very healthy return for a short term holding period.
So I am covered (no pun intended) with just about every exit strategy. If the stock goes nowhere or goes down, I sit back and collect dividends and option premiums. If the stock goes up beyond the strike price, I collect profit on stock appreciation and some option premiums on the way. Win-win.
Do you use covered call options in your stock investing strategies? What do you think of my current strategy? Drop a comment and let me know what you think.
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