Too good to be true?
Hardly, because I know firsthand of investors doubling their income on long-standing High Yield Wealth dividend growers McDonald’s (NYSE: MCD), Altria (NYSE: MO), and AT&T (NYSE: T).
The difference is these investors aren’t waiting for these blue-chips companies to grow the dividend, which these companies do faithfully each year. Instead, these investors are employing a simple and safe pro-active strategy to double their income.
I’m referring to a covered-call strategy – my favorite strategy to boost income and yield on the world’s best dividend stocks.
The good news is that any investor can boost his income with a covered-call strategy: All you need is enough capital to buy 100 shares and an online brokerage account.
Here’s how it works. You simply buy 100 shares of a stock like McDonald’s, Altria or AT&T and sell one call option on the 100 shares. In exchange for selling the call option, you receive an upfront premium payment.
I understand that many investors are put off by options – they view them as risky or as difficult-to-trade instruments.
Don’t be put off, because options aren’t risky in the context of a covered call, nor are they difficult to trade. Most online brokers permit options trading. In most cases, if you already have a margin account with your online broker, you can start trading immediately.
Combining the Best Dividend Stocks with a Covered Call Strategy
I’ll use McDonald’s to demonstrate just how simple it is to implement and profit from a covered-call strategy.
McDonald’s is one of my favorite dividend stocks. It has increased its dividend annually every year since 1976. Needless to say, McDonald’s isn’t just a favorite of mine. It’s a favorite of many income investors, which is why it yields only 3.1% based on a $97.50 share price and a $3.08 annual dividend.
By overlaying McDonald’s shares with a covered call, though, you can more than double your income and yield.
As I write, you can sell an August 2013 105 call option on McDonald’s for the equivalent of $0.63 a share (each call option covers 100 shares). This gives the buyer the right to call away 100 shares of McDonald’s at a price of $105 a share for the next two months. In exchange, you receive a $63 payment.
Now, imagine selling a similarly priced call option on McDonald’s six times – every two months – over a 12-month period. Every two months, you’d receive $63 (less the brokerage fee), so over 12 months you’d receive $378 in premium payments.
Of course, you’d also receive the $308 in dividends on the 100 McDonald’s shares you own.
Over a 12-month period, instead of receiving $308 in income on your McDonald’s share, you’d receive $686. You’ve more than doubled your income, and you’ve hiked the current yield to 6.9% from 3.1%.
The risk in the strategy should be apparent: McDonald’s share price could rise above $105, and the shares would be called away. In that case, though, you would still book an additional $5.50 per share, so you wouldn’t suffer a monetary loss.
That said, McDonald’s is a low-volatility stock, with a beta below 0.50. In other words, its share price tends to move half as much as the overall market.
And because you are resetting the strike price – the share price at which the shares can be called away – every two months, the probability is high that your shares won’t be called away.
Altria and AT&T are low-volatility stocks as well. The share price of both these companies also tend to move half as much as the overall market. What’s more, Altria and AT&T shares are highly liquid – like McDonald’s shares – so their options are highly liquid.
So don’t buy into the fear-mongering about options. In a market starved for income, covered-call strategies offer the opportunity to safely increase income on the world’s best dividend stocks.