Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Dividend Investors Can Use Options for Extra Income
Transcript
- Lucas: The 10-year Treasury yield is at 4.56 percent as of this morning, the 30-year is above 5 percent for the first time in months, and yet the S&P 500 dividend yield is sitting around 1.3 percent. Luna: So for income investors, bonds are suddenly competitive. But you can't live on capital appreciation alone if you need cash flow. Lucas: Exactly. That's why I want to talk about something we haven't covered yet on this show: using options — specifically covered calls and cash-secured puts — to boost the effective yield on dividend stocks you already own or want to own. Luna: Before we dive in — and I know this is a bit off the main thread — but we've been doing this show without any ads, and a lot of listeners have asked how they can support that. If you find these conversations useful, the simplest way is buy me a coffee dot com slash fexingo. That's it. No tiers, no perks, just helps us keep the show ad-free. Lucas: Yeah, and we really appreciate that. It lets us focus on what's actually interesting rather than filling time with sponsor reads. So back to options — let's start with a specific stock. Coca-Cola, ticker K-O, trades at $81.34. It yields about 3 percent from its dividend. But if you sell a covered call — say a $85 call expiring in a month — you might collect a premium of roughly 50 cents per share. Luna: That's about 0.6 percent extra in one month. Annualized, that's over 7 percent. Combined with the dividend, you're looking at a 10 percent yield. But you cap your upside. Lucas: Right. If Coke goes above $85, you're obligated to sell at that price. But if you're holding long-term and you're comfortable with that strike, it's essentially free money from time decay. The key is to sell calls at a strike you'd be happy to sell at anyway. Luna: What about cash-secured puts? How does that work for dividend investors? Lucas: Say you want to buy Johnson & Johnson, ticker J-N-J, at $237.00 but you think it might dip. Instead of buying now, you sell a put at $230 with a month to expiry. You collect premium — maybe $1.50 per share. If the stock stays above $230, you keep the premium and try again. If it drops below $230, you buy the stock at a discount and start collecting the dividend. Luna: So you're getting paid to wait. But there's risk: if the stock crashes, you're still obligated to buy at $230, which could be above the market price. Lucas: That's why you only do this on stocks you're happy to own long-term. Johnson & Johnson yields about 3.2 percent, so even if you get assigned at $230, your effective cost basis is lower because of the premium. Plus you start collecting the dividend. Luna: And with the Fed funds rate at 3.62 percent, the cash you set aside for the put earns interest too. Not huge, but it adds up. Lucas: Exactly. Let's put some numbers on it. If you have $23,000 cash to secure a put on JNJ, that cash sitting in a money market earning 3.6 percent gives you about $69 a month. The put premium might add another $150. So you're earning nearly $220 a month while waiting to buy a stock you want. Luna: Compared to just buying the stock outright and collecting the dividend, that's a meaningful boost. But what about the tax treatment? Options premiums are short-term capital gains, while dividends can be qualified. Lucas: That's an important nuance. Qualified dividends are taxed at lower rates. Options income is treated as ordinary income or short-term gains. So if you're in a high tax bracket, you need to factor that in. But for many investors in lower brackets, the extra yield still makes sense. Luna: Let's talk about the broader environment. The 30-year yield at 5.03 percent is tempting. Why would an income investor bother with options on dividend stocks instead of just buying treasuries? Lucas: Two reasons. First, dividend stocks offer growth potential. Coca-Cola raises its dividend every year. Treasuries don't. Second, options strategies can push your yield above 8 or 9 percent on high-quality stocks. That's hard to get from bonds without taking credit risk. Luna: Fair point. So who is this strategy best suited for? Someone who already holds dividend stocks and wants to juice the yield without adding more risk? Lucas: Ideally, yes. If you're a long-term holder of something like Procter & Gamble at $148.67, and you don't mind selling at $155, you can sell calls month after month. The risk is that the stock runs past your strike and you miss out. But if you're disciplined about rolling the option or letting it get called away and then selling puts to re-enter, it becomes a cycle. Luna: That sounds like a lot of management. Is this better suited for someone with more time to monitor positions? Lucas: It does require some attention. But you can set it up to be fairly passive. Sell the call at the beginning of the month, let it expire, collect the premium. If it gets exercised, you deal with it then. Many brokers offer automated roll strategies now too. Luna: Is there a scenario where this backfires badly? Like if the stock gets called away right before an ex-dividend date? Lucas: That's a real risk. If you sell a call and the stock goes ex-dividend, the option may get exercised early to capture the dividend. So you might lose the stock and miss the dividend. To avoid that, you can sell calls that expire after the ex-date, or simply accept the risk and factor it into your strike. Luna: So it's not a set-and-forget strategy. But for someone willing to put in a little effort, it can turn a 3 percent yield into 7 or 8 percent on solid companies like Coke, JNJ, or PG. Lucas: Exactly. And with the small-cap index, the Russell 2000, down 1.3 percent in the past five days, volatility is picking up. Higher volatility means higher option premiums. So this might be a good time to start for those who haven't tried it. Luna: One last question: what about using options on dividend ETFs like VYM at $158.84 or SCHD at $32.39? Are those easier or harder? Lucas: ETFs are actually great for this because they're diversified. Selling a covered call on VYM gives you exposure to a basket of high-dividend stocks. The premiums might be slightly lower because ETFs are less volatile than individual stocks, but the risk of a single stock blowing up is reduced. It's a trade-off. Luna: So for conservative income investors, ETF options might be the sweet spot. For those willing to bet on specific names, individual stock options offer more juice. Lucas: Right. And I should mention: never sell a covered call on a stock you're not willing to hold through a downturn. If the stock drops, you still own it and collect the dividend, but the option premium only softens the blow a little. Luna: It's a tool, not a miracle. But used wisely, it can help fill the gap when bonds are yielding more than dividend stocks. Lucas: Exactly. Next time, we'll look at how to choose the right strike and expiration to minimize risk. For now, the takeaway is: if you're sitting on dividend stocks and want extra income, selling calls or puts — with discipline — is a legitimate strategy. Luna: And if you want to support the show so we keep doing deep dives like this, you know the link: buy me a coffee dot com slash fexingo. Thanks for listening.