If you’re like most investors, you’re probably a little hesitant to plunk money down in this market.
Is it worth the risk at these heightened levels? We’ve gained 195% over the past six years’ how much more can this bull market run?
According to Nobel Prize winner Robert Shiller, the market is not cheap. In fact, he said the market is looking unusually expensive. He points to the one of the most closely followed valuation metrics, the cyclically adjusted price-earnings (CAPE) ratio, to prove his justification.
The CAPE ratio is the price of the stock market divided by the average of 10 years’ worth of earnings.
As you can see from the chart above, we are back at historic levels.
Last week Shiller stated, “As of yesterday my price-earnings ratio … was 26.3.” . . . “There are only three major occasions in U.S. history back to 1881 when it was higher than that. One is 1929, the year of the crash. The other is 2000, which I call the peak of the millennium bubble, and it was also followed by a crash. And then 2007, which was also followed by a crash.”
So why not just take money off the table, put it in bonds and be done with it?
Well, there’s a way that investors can KEEP their stocks AND continue to make profits even if the market takes a turn for the worst.
But what if I told you that you could increase your income and yield on AT&T by 75% or more each year? And what if I told you that you could collect this extra income every few months in addition to your regular quarterly dividend?
I’m referring to an option strategy known as a covered call, which allows you to collect extra income from a conservative dividend stock like AT&T NYSE: T).
When I mention “options” to many investors, they instantly think of risky investments that are only for speculators.
Nothing could be further from the truth.
An option is simply a contract to buy or sell shares of a stock at an agreed-upon price (the strike price) at a future date. Options can be used to control large blocks of stock for a small price. But they also can be used to earn income or reduce risk.
With a covered-call strategy, you buy shares of a specific stock and then sell a call option on that same stock. By doing so, you agree to sell the position at a future date and price to another investor. In exchange for giving the other investor the right to purchase the shares at a future date and price, you earn a premium in the form of a one-time upfront payment – the extra income.
So how does a covered-call strategy work with, say, a big blue-chip company like AT&T?
First, you need to own at least 100 shares of AT&T. I say that because 100 shares of stock equals one option contract. Once you own the 100 shares, you’re ready to start generating extra income.
Now, let’s create the income-generating scenario: AT&T trades at roughly $35.50, which produces the 5.10% yield. By selling one covered-call contract against 100 shares of AT&T, you can earn an extra $23 every two months.
So every 60 days, you give yourself the potential to collect $52 against 100 shares of AT&T. Annually, that equates to $312 of extra income. This strategy safely doubles, in fact almost triples, the dividend of the stock.
By implementing a covered-call strategy, you’ve taken an already high-yield income investment, AT&T, and boosted your potential income to $4.92 per share from $1.80 a share and your yield to 13.8% from 5.10%.
If the CAPE ratio once again holds true and the market struggles over the intermediate term, implementing a covered-call strategy on stocks you already own is a great way to hedge your portfolio. And if you are just looking for additional income, covered calls are THE BEST WAY to accomplish your income goals.
If you would like to learn more on how I use covered calls in my portfolio, click here.