Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Dividend Investors Can Use Covered Calls for Extra Income
Transcript
- Lucas: So the Fed held rates steady yesterday, and Chairman Warsh basically took a hatchet to the statement's forward guidance. The cutting bias is gone. And for dividend investors, that means one thing — the search for income just got a little harder. Luna: Yeah, I saw that. The ten-year is down to 4.43 percent, but that's still well above where we were a year ago. And with rates likely staying here, dividend stocks aren't exactly cheap. Lucas: Right. Which is why I want to talk about a strategy that a lot of income-focused investors overlook — using covered calls to boost yield on the dividend stocks you already own. It's not new, but in this environment, it's worth revisiting. Luna: Covered calls. So you own the stock, you sell a call option against it, you collect the premium. But you cap your upside if the stock rallies. That's the trade-off. Lucas: Exactly. And the key is to do it on stocks where you're already comfortable holding long-term. Take Verizon, ticker V-Z. It's down about two point three percent over the past five days, trading around forty-five eighty-four. The dividend yield is north of five percent. Luna: So if you're holding Verizon for that five percent yield, writing a monthly call might add another one to two percent in premium. That could push your effective yield to six or seven percent. Lucas: Exactly. But you have to be careful. If Verizon jumps above your strike price, your shares get called away. You capture the gain up to the strike, plus the premium, plus any dividends — but you lose the stock. So you'd better be okay with that. Luna: And the timing matters. You don't want to write a call right before an earnings report or a dividend ex-date, because the option will be more expensive, sure, but the risk of assignment goes up. Lucas: Right. A lot of retail investors get burned writing calls too close to ex-dividend. The option gets exercised early, they lose the stock, and they miss the dividend. So you want to write calls that expire after the ex-date, ideally. Luna: Let's talk about another name. Realty Income, ticker O. It's down about two point two percent over the past five days, trading at sixty fifty-seven. That's a REIT with a monthly dividend. Lucas: Realty Income is a classic covered call candidate. The stock is range-bound, it's not super volatile. If you sell a call with a strike maybe two or three dollars above the current price, you collect premium and you probably don't get assigned unless there's a big move. Luna: And with the dividend yield around five and a half percent, adding a covered call could push the total return into the seven to eight percent range. That's competitive with a lot of bonds, even with the ten-year at four point four three. Lucas: Exactly. And that's the whole point. In a world where the Fed is holding steady and the bond market is saying rates are here for a while, you need to get creative. Covered calls aren't for everyone, but if you're a long-term holder of a stock like Verizon or Realty Income, it's a way to turn a four percent yield into a six percent yield. Luna: What about taxes? Because the premium from the call is short-term capital gains unless you hold the option for more than a year, which nobody does. So you're generating ordinary income on top of potentially qualified dividends. Lucas: That's a good point. The premium is taxed as ordinary income. The dividends from Verizon are qualified, so lower rate. But if you're in a high tax bracket, that extra income might not be as attractive. You have to run the numbers. Luna: And there's also the risk that the stock drops. The covered call doesn't protect you on the downside. You still own the stock, and if it falls, you lose money. The premium only cushions the blow a little. Lucas: Right. So it's not a hedging strategy. It's an income enhancement strategy. You should only do it on stocks you're willing to hold through a downturn. And you should size the position accordingly. Luna: So how does someone actually get started? Say I own a hundred shares of Verizon. What's the next step? Lucas: You look at the options chain. Pick a strike price that's above where you think the stock will be by expiration. And pick an expiration that's maybe thirty to forty-five days out. That's where the premium decay is fastest. You want to capture that time decay. Luna: And you can do this every month. Rinse and repeat. If you get assigned, you sell the stock at the strike price, you keep the premium, and then you can buy back in if you want. Or move on to another stock. Lucas: Exactly. It's a discipline. And in this rate environment, with the Fed signaling no cuts anytime soon, it's a tool worth having in the toolkit. Luna: One more thing — what about the new Fed statement? Warsh removed the cutting bias. Does that change the calculus for dividend investors using options? Lucas: I think it reinforces the idea that we're in a higher for longer rate regime. That means bond yields stay competitive, so dividend stocks need to offer more. Covered calls are one way to bridge that gap. But it also means you might see more volatility if the market re-prices expectations. And volatility is good for option sellers. Luna: Higher volatility means higher premiums. So in a way, the Fed holding steady actually makes covered calls more attractive. Lucas: Exactly. So if you're a dividend investor looking to juice your yield, it's worth a look. Just make sure you understand the mechanics and the risks. Luna: On that note, we should mention — this show is ad-free, and it stays that way because of listeners who chip in. If these conversations have helped you think about your portfolio differently, you can find us at buy me a coffee dot com slash fexingo. No pressure, just a way to keep the lights on. Lucas: Yeah, it's a small group that makes this possible. And we're grateful. It lets us keep the focus on actionable ideas, not on selling you something. Luna: Alright, back to the strategy. One last thing — if you're going to try covered calls, start small. Maybe one position, see how it feels. The last thing you want is to get your shares called away on a stock you really wanted to keep. Lucas: Good advice. And remember, the goal is income, not speculation. If you're writing calls just to collect premium on a stock you don't want to own, that's a different game entirely. Stay disciplined, stay focused on the dividend. Luna: Next episode, we'll look at another way to boost yield — maybe something with preferred stocks or baby bonds. There's a lot out there. Lucas: There is. And with rates where they are, every basis point counts. Thanks for listening.