Dividends Plus Options – The Evolution of My Stock Investing Strategy

After my recent return to stock investing, my strategy for how to invest has evolved. The strategy change corresponds with a circumstance change. I’ll explain.

I began with a modest sized account and a basic, hands-off approach to my stock account. I bought some dividend paying stocks and some non-dividend stocks that were potentially ripe for gains over time. The strategy was a mix of dividends and price appreciation, a long-term approach.

I bought some stocks with the cash I had in my Scottrade account and basically left it alone. All of the stock picks were recommendations from The Motley Fool, my favorite investing service.

I didn’t check the account that often. I was preoccupied with my side gig, starting up a real estate business. That consumed so much of my time that I stopped watching stocks and stopped tracking my finances. One of those turned out to be a bad idea.

Financial Woes

While I had my head down with my real estate business, I wasn’t minding the financial store. Prior to this, I had begun tracking some financial metrics, like my net worth, total debt, and debt-to-income ratio. I made a major change to my finances by getting a large personal loan to consolidate my debt.

The loan worked amazingly! I paid off five credit cards right away…FIVE! I was on financial cloud nine.

My FICO score sky rocketed. I saved hundreds of dollars in monthly interest expenses to credit card companies. My financial metrics improved. I was so excited.

I felt so good about solving a huge problem on the expense side of our budget that I jumped into increasing the income side of our budget with my side gig. The problem there was that I didn’t continue tracking things. I left it all alone and moved on.

The ugly truth hit about 6 months later. We had run up our credit card debt again on some of the credit cards that I had paid off. Uggh!

We didn’t correct our biggest problem…the habits that drove us to overspend by using credit cards. I was using a card to fund my real estate business, so at least some of those expenses will come back at tax time under my business LLC. But we never addressed our regular spending and ran up another terrible bunch of credit card debt.

Back to Investing

When I wasn’t able to make any headway with my real estate side gig (closed zero deals, brought in zero revenue), I pulled back and looked at our finances again. I was shocked at the climbing debt…and pissed!

After my pity party and marital arguments, I collected myself and dove back into my investing accounts. They were about the only thing that I could make sense of at the time. The only control I could assert over our finances.

I had been automatically depositing cash each week into my accounts, but not paying much attention. Now, I was going to pay close attention. Look out, here comes the part where I obsess over something.

New Investing Strategy

I dove into my spreadsheets, investing articles, and countless blog posts on investing. I was in obsession mode.

I came out the other end with a new (or updated) investing strategy. I was looking for income from my investments. No longer would I focus on price appreciation on stocks. That would be a secondary goal. I also changed my focus to a more short-term outlook, no longer focused on long-term gains.

Income meant dividends, but with a twist. The twist part involves options trading, where you can leverage your underlying stocks for greater gains. I’m only focusing on covered calls to start, which are probably the most basic option trades available. They are very conservative.

So we have dividend stocks and covered call options. Let me explain how I’m putting that all together in a short-term package. Here is the new strategy for stocks…

• Buy dividend paying stocks, generally with a dividend yield of 3% or greater, that are going nowhere with price appreciation or slightly up.
• Target stocks where I can buy 100 shares of the stock, which means under $18 per share to start with my small account.
• Buy only companies that I would want to hold long-term, which means Motley Fool recommended stocks for the most part.
• Sell covered call options on the stock after purchase, targeting higher premium options, when available.
• Target an option strike price that will give a gain of 9% or more if the stock is called away with the call option.
• If the call option expires (meaning the stock didn’t reach the strike price), then I will sell another covered call option. If covered calls are no longer viable on the stock, I will look to sell the stock for a gain.

Here is a recent trade I made, to illustrate the process…

• Bought 100 shares of MHLD on 7/20/16 at $12.83, minus commission cost of $7.00.
• The dividend yield was just over 4% when I purchased.
• Sold to Open 1 contract of MHLD FEB 17 2017 15.00 C on 7/20/16 at $0.45, minus commission of $7.70, collected premium of $37.30.
• Will collect two dividend payments between purchase and the call option expiring, for a total of $28.00.
• If the stock price is above $15.00 when the call option expires in February, the stock will get called away and my total return after commissions will be $261.10, or 20.2%.
• If the stock price is below $15.00 at expiration, the return will be $65.30 (option premium plus dividends) after commissions, and I will keep the stock. I could then sell another call option and do it again, provided the stock price appears to be appreciating towards $15 per share again, and I will continue collecting $14.00 in dividends every quarter.

I currently own covered call positions for the following options, and you can see the potential returns (includes stock appreciation to strike price, dividends, and option premium):

GES SEP 16 2016 16.00 C – $186.10, 12.7%
GPT SEP 16 2016 10.00 C – $155.73, 18.3%
NOK SEP 16 2016 6.00 C – $73.10, 14.1%
NOK OCT 21 2016 6.00 C – $74.10, 14.3%
MHLD FEB 17 2017 15.00 C – $261.10, 20.2%

September is going to be a big month if all three stocks are called away. My goal is to get to the point where I have a covered call position expiring every month. Then I will look to get to two positions expiring every month.

The benefit here is that I collect dividends while I wait to see if my stock position will get called away. And if I keep the stock after the option expires, I continue collecting dividends and find another option trade where I can collect a premium.

The downside is that I tie up most of my account in a few positions. Another downside is if the stock starts going down steadily, the option values go down as well. If the stock doesn’t get called away, finding the next option to sell may be difficult, depending on the stock and current situation.

I actually want the stock to get called away because I build in my profit before purchasing the stock. Sort of like with real estate investing, when they say that you make your profit when you buy the house, not when you sell it. The idea is that I go into these trades knowing what I will gain on the back end. I’m not hoping for something good to happen in the short-term, like a price spike. I’m looking for a steady, conservative return.

That’s why I am targeting option strike prices that are “in the money.” I want the profit of the trade. Eventually I may begin targeting strike prices that are “out of the money,” but for now I want to gain income on each trade.

Have you ever used options to leverage your stock strategy? Ever tried covered calls? What is your stock investing strategy?

Thanks for reading my financial ramblings. Leave a comment to add to the discussion of give your thoughts on stock investing, options, or anything in between.

Follow me on Twitter as well for more ramblings.

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