Note from Daily Trade Alert: We recently launched a new, regular column here at Daily Trade Alert called High-Yield Trade of the Week. The goal of this column is to show our readers how to safely boost their income from some of the best stocks in the world. It’s our sincere hope that you benefit from this new service.
A few days ago we featured an interesting piece from Chuck Carnevale, creator of the FAST Graphs valuation software.
In his article, Chuck pointed out that he manages dividend growth portfolios for clients that are retired, and as such, they require yields of at least 3% “in order to live on.”
As a result, Chuck said he’s not currently invested in Lowe’s (LOW) because its 2.2% yield doesn’t meet his 3%-plus dividend threshold.
This dilemma is one that many retirees are facing today: They long to collect safe, growing income from some of the world’s best companies, but they simply can’t afford to live off their low current yields.
Unfortunately, in their search for higher income, these investors are forced to overlook high-quality dividend growers such as Disney, Starbucks, Nike, Microsoft and, as Chuck pointed out, Lowe’s… simply because they yield less than 3%.
But it doesn’t have to be this way.
With a “high-yield trade”, it’s entirely possible to collect safe, high income from these very same companies.
It’s a strategy that I personally use in my retirement accounts (401k and Roth IRA), and one that’s engineered to boost our annualized income from some of the best companies in the world.
In short, the strategy I’m talking about involves selling a cash-secured put or a covered call on a high-quality dividend growth stock when it’s trading at a reasonable price (which is typically at or below fair value).
In fact, I made one of these high-yield trades with Lowe’s (LOW) yesterday… and I’m generating significantly more income (3.4% vs. 2.2%) in significantly less time (36 days vs 12 months).
You can find the details of my specific trade in today’s issue of our sister newsletter, Trades Of The Day.
However, since share prices and options premiums are constantly changing, the numbers below are even more current (and actually better) than the trade I made yesterday.
Here’s the opportunity we’re looking at today…
High-Yield Trade of the Week:
Sell the September 29, 2017, $75.50 calls on shares of Lowe’s (LOW)
As we go to press, LOW is selling for $73.80 per share and the September 29 $75.50 calls are going for about $1.96 per share.
Our trade would involve buying 100 shares of LOW and simultaneously selling one of those calls.
By selling a call option, we would be giving the buyer of the option the right, but not the obligation, to purchase our 100 shares at $75.50 per share (the “strike” price) anytime before September 29 (the contract “expiration” date).
In exchange for that opportunity, the buyer of the option would be paying us $1.96 per share (the “premium”).
Because we’re collecting immediate income when we open the trade, we’re lowering our cost basis on the shares we’re buying.
That’s what makes this trade safer than simply purchasing shares of the underlying stock the “traditional” way.
With all of this in mind, there are two likely ways our High-Yield Trade of the Week would work out, and they both offer significantly higher income than what we’d collect if we relied on the stock’s dividends alone.
To be conservative, we don’t include any dividends in our calculations for either of the following scenarios. The annualized yields are generated from options premium and applicable capital gains alone. So any dividends collected are just “bonus” that will boost our overall annualized yields even further. Let’s take a closer look at each scenario…
Scenario #1: LOW stays under $75.50 by September 29
If LOW stays under $75.50 by September 29, our options contract would expire and we’d get to keep our 100 shares.
In the process, we’d receive $196 in premium ($1.96 x 100 shares).
That income would be collected instantly, when the trade opens.
Excluding any commissions, if “Scenario 1″ plays out, we’d receive a 2.7% yield for selling the covered call ($1.96 / $73.80) in 42 days. That works out to an 23.1% annualized yield.
Scenario #2: LOW climbs over $75.50 by September 29
If LOW climbs over $75.50 by September 29, our 100 shares will get sold (“called away”) at $75.50 per share.
In “Scenario 2” — like “Scenario 1” — we’d collect an instant $196 in premium ($1.96 x 100 shares) when the trade opens. We’d also generate $170 in capital gains ($1.70 x 100) when the trade closes because we’d be buying 100 shares at $73.80 and selling them at $75.50.
In this scenario, excluding any commissions, we’d be looking at a $366 profit.
From a percentage standpoint, this scenario would deliver an instant 2.7% yield for selling the covered call ($1.96 / $73.80) and a 2.3% return from capital gains ($1.70/ $73.80).
At the end of the day, we’d be looking at a 5.0% total return in 42 days, which works out to a 43.1% annualized yield from LOW.
Here’s how we’d make the trade…
We’d place a “Buy-Write” options order with a Net Debit price of as close to $71.90 ($73.80 – $1.96) as we can get — the lower the better. Options contracts work in 100-share blocks, so we’d have to buy at least 100 shares of Lowes (LOW) for this trade. For every 100 shares we’d buy, we’d “Sell to Open” one options contract using a limit order. Accounting for the $196 in premium we’d collect, that would require a minimum investment of $7,190.
Good Trading!
Greg Patrick
P.S. We’d only make this trade if: 1) we wanted to own the underlying stock anyways 2) we believed it was trading at a reasonable price 3) we were comfortable owning it for the long-haul in case the price drops significantly below our cost basis by expiration and 4) we were comfortable letting it go if shares get called away. To be mindful of position sizing, except in rare cases, the value of this trade wouldn’t exceed 5% of our total portfolio value. In addition, to minimize taxes and tax paperwork, we would most likely make this trade in a retirement account, such as an IRA or 401(k).
Please note: We’re not registered financial advisors and these aren’t specific recommendations for you as an individual. Each of our readers have different financial situations, risk tolerance, goals, time frames, etc. You should also be aware that some of the trade details (specifically stock prices and options premiums) are certain to change from the time we do our research, to the time we publish our article, to the time you’re alerted about it. So please don’t attempt to make this trade yourself without first doing your own due diligence and research.