Before I get into this week's article, I want to tell you about a free event I'm holding next week. I'm holding a LIVE options webinar on Thursday, November 29th at 6 pm EST, and I'd like to give you a chance to sign up today. We have a limited number of seats available for this webinar, and as a valued reader, I want you to be able to take part.
I'll be discussing “My Step-By-Step Approach to Safely Collecting Monthly Income.” And I'll field questions from the audience.
If you've ever had any questions my options strategy and would like to talk with me personally, next Monday is your best chance. Click here to secure your spot.
Thanksgiving Day is upon us.
And unfortunately, so is the fiscal cliff.
If you’re a dividend investor, you should be concerned about the implications of the fiscal fiasco. The threat of an armadebton will most likely force Congress to increase the current dividend tax rate of 15% to as much as 39.6% for the wealthiest Americans. Add Obamacare’s 3.8% extra income tax on dividends, interest and capital gains, and 2013 could spell the end of a 10-year bull run for dividend stocks.
The added tax will no doubt have a profound effect on the wallets of dividend investors nationwide.
I am truly concerned for investors who use dividends as a source of income because they could potentially pay three times as much tax on the dividends they receive.
And if you are one of the few who think Congress will not have the fortitude to raise dividend taxes … think again.
Why do you think Wal-Mart just moved up their fourth-quarter dividend payout from early January to December? The retail behemoth’s decision is a reflection of all the uncertainty surrounding the dividend cliff. It’s certainly not a vote of confidence toward Congress. Wal-Mart is essentially hedging their bets to make sure company insiders as well as shareholders don’t get dinged by Uncle Sam.
So if one of the largest companies in the world is hedging their bets, you should be prepared to do so as well. And I have a way you can do it …
I’m about to teach you how to choose your own dividend. That’s right, you choose your own dividend.
The time has come for the average investor – either wealthy or in the process of accumulating wealth – to consider using covered calls.
If you own a stock that has a liquid options market, you MUST consider using a covered-call strategy. It’s not complicated and can add significant overall gains to your portfolio, particularly with the advent of a new tax structure on dividends.
So what is a covered call?
A covered call is an options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset to generate increased income.
For example, let's say that you own shares of Wal-Mart (NYSE: WMT). You like the stock’s long-term prospects as well as its share price, but feel the stock will likely trade relatively flat to lower over the next couple of months. Let’s assume that you think the stocks will stay within a dollar or two of its current price – $69.
For every 100 shares of WMT that you own, you can sell a call option with a strike price of $72.50. That option gives the buyer the right to buy your shares for $72.50 apiece, no matter how high the price goes before the option expires. For that right, you earn the premium from the option sale.
For this trade, one of three scenarios can play out:
a) WMT shares trade flat (below the $72.50 strike price) – the option will expire worthless and you keep the premium from the option. In this case, by using the covered call strategy you have successfully outperformed the stock.
b) WMT shares fall – the option expires worthless, you keep the premium, and again you outperform the stock.
c) WMT shares rise above $72.50 – the option is exercised, and your upside is capped at $72.50, plus the option premium. In this case, if the stock price goes higher than $72.50 plus the premium, your covered call strategy has underperformed the stock.
Most investors think of options as high-risk, speculative strategies where large losses can be incurred. While this is certainly true of some options strategies, covered calls are actually more conservative than investing in stocks or ETFs alone.
In other words, a covered-call strategy is SAFER than buying a stock or an ETF. Why?
Because covered calls:
- Allow you to bring in a steady stream of income. Best of all, depending on your risk profile, you choose you own dividend.
- Provide some protection in a down market.
- Are one of few ways an index investor can achieve double-digit returns in a flat or slow-growth market.
- Lower your cost basis while decreasing the volatility of your portfolio.
Remember, covered calls make money when stocks are slightly higher, flat or down. You only get the underlying stock "called" away if it rises significantly.
So again, why would any investor choose to shy away from such a proven income strategy that has outperformed the market and dividend-paying stocks over the long term?
I realize the aforementioned discussion is brief (my managing editor is already going to have a fit about the length of this article). So if you’d like to read more about how I use covered calls, check out the following articles:
Over the next few weeks I will discuss a few real-life examples either here in Daily Profit or in my FREE weekly, The Strike Price (click to join). Stay tuned!!!
As always, if you have any questions regarding covered calls or options in general please do not hesitate to email me at [email protected].
Editor and Chief Options Strategist