Note from Daily Trade Alert: A few weeks ago we 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.
As a long-term investment, Hormel Foods (HRL) looks attractive today.
It may not be a bargain, but it is a high-quality dividend growth stock trading at a reasonable price.
This kind of “buy and hold” strategy, coupled with an elite dividend growth stock like Hormel, could set you up for decades of safe, steadily-growing passive income.
But, there’s a catch with this kind of investing, and it’s a deal-breaker for many investors.
You need time.
The problem is, what if you don’t have time? What if you’re nearing or already in retirement and you need high income right now?
That’s the dilemma for many older investors who recognize the power of dividend growth investing, but simply can’t wait decades for the strategy to deliver the high income they need today.
Case-in-point, anyone who buys Hormel today will get an entry yield of just 2.0%. That’s peanuts.
But what if we could make a trade right now with those very same shares that boosts our income significantly — generating an annualized yield of 12.1% to 43.2%?
That’s over six times the stock’s “normal” annual income (if you’re relying solely on dividends).
And what if this trade was actually safer than buying the stock the “traditional” way?
It’s a strategy that I personally use in my retirement accounts (401k and Roth IRA), and one that’s engineered to pay 10%-plus 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).
Here’s how it works…
High-Yield Trade of the Week:
Sell the September 15, 2017, $35.00 calls on shares of Hormel Foods (HRL)
As we go to press, HRL is selling for $33.79 per share and the September 15 $35.00 calls are going for about $0.47 per share.
Our trade would involve buying 100 shares of HRL 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 $35.00 per share (the “strike” price) anytime before September 15 (the contract “expiration” date).
In exchange for that opportunity, the buyer of the option would be paying us $0.47 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: HRL stays under $35.00 by September 15
If HRL stays under $35.00 by September 15 our options contract would expire and we’d get to keep our 100 shares.
In the process, we’d receive $47 in premium ($0.47 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 1.4% yield for selling the covered call ($0.47 / $33.79) in 42 days. That works out to a 12.1% annualized yield.
Scenario #2: HRL climbs over $35.00 by September 15
If HRL climbs over $35.00 by September 15 our 100 shares will get sold (“called away”) at $35.00 per share.
In “Scenario 2” — like “Scenario 1” — we’d collect an instant $47 in premium ($0.47 x 100 shares) when the trade opens. We’d also generate $121 in capital gains ($1.21 x 100) when the trade closes because we’d be buying 100 shares at $33.79 and selling them at $35.00.
In this scenario, excluding any commissions, we’d be looking at a $168 profit.
From a percentage standpoint, this scenario would deliver an instant 1.4% yield for selling the covered call ($0.47 / $33.79) and a 3.6% return from capital gains ($1.21/ $33.79).
At the end of the day, we’d be looking at a 5.0% total return in 42 days, which works out to a 43.2% annualized yield from HRL.
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 $33.32 ($33.79 – $0.47) 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 Hormel Foods (HRL) 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 $47 in premium we’d collect, that would require a minimum investment of $3,332.
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.