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Update: 8/11/2015
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Thursday, January 31, 2008
Tuesday, January 29, 2008
An alternative strategy to covered calls
Instead of selling covered calls, I actually am considering selling put options on stocks for some extra income, which could work in some situations. First, when you are selling a naked put you are obligated to buy the stock from the put buyer, who has the right, but not the obligation to sell it to you at a predetermined strike price. If you invest a certain amount of funds each month into stocks for example, you are basically always buying at the market price. If you always invest 120-125 dollars per month in DIA you are trying to buy one share per month at a time, rather than all 12 at once, by using the power of dollar cost averaging. In this situation, if you sell a naked put on DIA at an in the money strike of say 122, you would be paid $3.10 for the obligation to buy DIA at $122. If DIA does fall below 122 at expiration, you most probably would have to buy it at the strike price. With this strategy you bring your cost basis significantly below the current market price of 122.19 to an actual $118.90 if your option is exercised. Since stocks have historically always been in a bull market over the past 200 years, it makes sense to me to buy stocks that have shown some weakness, get dividend payments and live the good life.
The shortfall in this strategy is that you are only buying stocks which are showing weakness. In a strong market you will miss on potential gains, because you are only buying a stock that has fallen below your strike price and thus there’s no guarantee that that you will receive the lower cost basis. In weak markets you will be able to buy your stock at a lower price, but you will see your stock dive further down. Thus you might have been better off postponing your buy.
Relevant Articles:
- Dividend Aristocrats List for 2009
- Dividend Aristocrats
- Best Dividends Stocks for the Long Run
- Best High Yield Dividend Stocks for 2009
- Best CD Rates
- Covered Call Options Strategy for cutting losses
The shortfall in this strategy is that you are only buying stocks which are showing weakness. In a strong market you will miss on potential gains, because you are only buying a stock that has fallen below your strike price and thus there’s no guarantee that that you will receive the lower cost basis. In weak markets you will be able to buy your stock at a lower price, but you will see your stock dive further down. Thus you might have been better off postponing your buy.
Relevant Articles:
- Dividend Aristocrats List for 2009
- Dividend Aristocrats
- Best Dividends Stocks for the Long Run
- Best High Yield Dividend Stocks for 2009
- Best CD Rates
- Covered Call Options Strategy for cutting losses
Monday, January 28, 2008
Covered Calls for additional income
A friend of mine suggested to me to sell covered calls on the dividend stocks that I own, in order to increase my income. Basically that means that I will sell an out of the money call option on a stock I already own at a given strike above the current price and collect the premium. This does sound appealing, because theoretically I could get two passive income streams from one stock. There are some risks with this strategy though, that make it less appealing to me:
First, when you sell an out of the money covered call option, you are basically betting that your stock would not increase above the strike price at which you’ve written the options. Thus if I owned Pepsi at $69, share and I sell a February covered call at the $75 strike; I would be betting that the price of Pepsi would not increase over $75 over the period. And I always expect that my stocks would go through the roof in any period, otherwise I wouldn’t have bought them in the first place.
Second, if the price rises to 80, I would not be able to participate in the upside gains above 75, because I am obligated to sell it to the call buyer to whom I wrote the call option to. The only scenario in which I will keep the stock and the premium is when the stock price does not increase above $75. This strategy seems inferior because it assumes that investors could time the market by betting whether or not the stock would be above/below the strike price at expiration. Studies have shown that investors are pretty bad at timing the markets, because the majority always seems to be selling at the bottoms and buying at the top. It also seems inferior because you are limiting your upside, and leaving your downside wide open. You are selling your rising stocks and keeping your losers, while earning some income in the process, which in reality is eroding your capital gains. The psychological weak points of this strategy is that most investors always believe that their stocks would be rising over time, so betting against your own portfolio in terms of covered call selling seems counterintuitive.
If I were simply interested in income, I would put all of my money in a bond yielding me 5% annually and simply compound the interest. I am in this game not only for the income potential but also for the capital gains. Thus I am not a believer in the covered call strategy. If I thought that my stock would not increase a lot, then I would sell it and buy a stock that I believe would increase a lot. Tomorrow I would write about another options strategy for generating income.
Relevant Articles:
- Dividend Aristocrats List for 2009
- Dividend Aristocrats
- Best Dividends Stocks for the Long Run
- Best High Yield Dividend Stocks for 2009
- Best CD Rates
- Covered Call Options Strategy for cutting losses
First, when you sell an out of the money covered call option, you are basically betting that your stock would not increase above the strike price at which you’ve written the options. Thus if I owned Pepsi at $69, share and I sell a February covered call at the $75 strike; I would be betting that the price of Pepsi would not increase over $75 over the period. And I always expect that my stocks would go through the roof in any period, otherwise I wouldn’t have bought them in the first place.
Second, if the price rises to 80, I would not be able to participate in the upside gains above 75, because I am obligated to sell it to the call buyer to whom I wrote the call option to. The only scenario in which I will keep the stock and the premium is when the stock price does not increase above $75. This strategy seems inferior because it assumes that investors could time the market by betting whether or not the stock would be above/below the strike price at expiration. Studies have shown that investors are pretty bad at timing the markets, because the majority always seems to be selling at the bottoms and buying at the top. It also seems inferior because you are limiting your upside, and leaving your downside wide open. You are selling your rising stocks and keeping your losers, while earning some income in the process, which in reality is eroding your capital gains. The psychological weak points of this strategy is that most investors always believe that their stocks would be rising over time, so betting against your own portfolio in terms of covered call selling seems counterintuitive.
If I were simply interested in income, I would put all of my money in a bond yielding me 5% annually and simply compound the interest. I am in this game not only for the income potential but also for the capital gains. Thus I am not a believer in the covered call strategy. If I thought that my stock would not increase a lot, then I would sell it and buy a stock that I believe would increase a lot. Tomorrow I would write about another options strategy for generating income.
Relevant Articles:
- Dividend Aristocrats List for 2009
- Dividend Aristocrats
- Best Dividends Stocks for the Long Run
- Best High Yield Dividend Stocks for 2009
- Best CD Rates
- Covered Call Options Strategy for cutting losses
Saturday, January 26, 2008
What’s a passive income from dividends?
Among the popular internet media there’s a widespread belief that passive income is income which you receive without even moving a finger. Although the term passive income implies that you simply receive checks or that the money is simply directly deposited into your bank account without any effort on your side, I think that that’s not the case in reality. An example of passive income that comes to mind is interest on Bonds that is paid to the holder at a fixed period. Other examples include royalties from music sales, which was created by artists long after their bands have fallen off the charts, income from rental properties, income from online advertising and income from dividends.
From these examples it is visible that passive income is a direct result of some economic activity or work, which created some good/service which society is still willing to reward the holder of the idea long into the future. If you buy stock in a corporation, you increase the liquidity of its shares, making it easier for the company to sell stock in the future to its shareholders. This liquidity also provides an incentive to shareholders to keep their wealth invested in stocks, because they would always be able to transform their paper wealth into dollars and consumption. Investors are further rewarded for holding stocks which reward them with dividend payments paid 4 times per year in the US. Some foreign corporations though, pay their dividends once a year, which provides an uneven stream of income for their shareholders, unlike US ones.
Studies have shown that dividend paying companies tend to outperform the general market over time. Thus I believe that a strategy of investing in stocks that regularly distribute their earnings to shareholders will provide one with a good return over time. Companies that pay dividends show that they care about their owners and have a good corporate policy toward them. Companies that not only pay dividends every year, but also strive at increasing them every year show confidence in the superiority of their business model relative to other industries. An investor, who puts his money to work in such a stock, will be rewarded with an ever increasing stream of income, which would compound at faster rates than simply putting ones money in a bank account.
Thus I believe that building a well-diversified portfolio of companies who have a history of consistently increasing their dividends over time is a good extra source of income for many people. It takes very little time to set up and implement, and can lead to very good returns in the future by reinvesting and compounding your dividends and spreading your buys over time.
I have attached a chart showing the dividend payments over time for Pepsi Co since 1977. If you had invested $1,000 back in those days into Pepsi Stock, your annual dividend income would have risen from $34 during your first year as a shareholder to $1071 in 2007. Furthermore, if you had simply reinvested these dividends every year, your initial $1000 investment would have grown to over $116,000. The main reason for this high number is dividend reinvestment - if you had spent your dividend payments each year instead of reinvesting them into company stock your investment would have been worth only $51,000. In addition, if you had kept on reinvesting your quarterly dividend payments, your annual income would have increased to over $2,000 in 2007. Of course this sort of capital gains might not be replicated in the future but one thing is for sure – if the company keeps expanding and raising its dividend payment year in and year out, I would be its stockholder. It’s very nice to have your salary increased every year. That’s what dividend aristocrats like Pepsi provide to their shareholders in terms of payments.
From these examples it is visible that passive income is a direct result of some economic activity or work, which created some good/service which society is still willing to reward the holder of the idea long into the future. If you buy stock in a corporation, you increase the liquidity of its shares, making it easier for the company to sell stock in the future to its shareholders. This liquidity also provides an incentive to shareholders to keep their wealth invested in stocks, because they would always be able to transform their paper wealth into dollars and consumption. Investors are further rewarded for holding stocks which reward them with dividend payments paid 4 times per year in the US. Some foreign corporations though, pay their dividends once a year, which provides an uneven stream of income for their shareholders, unlike US ones.
Studies have shown that dividend paying companies tend to outperform the general market over time. Thus I believe that a strategy of investing in stocks that regularly distribute their earnings to shareholders will provide one with a good return over time. Companies that pay dividends show that they care about their owners and have a good corporate policy toward them. Companies that not only pay dividends every year, but also strive at increasing them every year show confidence in the superiority of their business model relative to other industries. An investor, who puts his money to work in such a stock, will be rewarded with an ever increasing stream of income, which would compound at faster rates than simply putting ones money in a bank account.
Thus I believe that building a well-diversified portfolio of companies who have a history of consistently increasing their dividends over time is a good extra source of income for many people. It takes very little time to set up and implement, and can lead to very good returns in the future by reinvesting and compounding your dividends and spreading your buys over time.
I have attached a chart showing the dividend payments over time for Pepsi Co since 1977. If you had invested $1,000 back in those days into Pepsi Stock, your annual dividend income would have risen from $34 during your first year as a shareholder to $1071 in 2007. Furthermore, if you had simply reinvested these dividends every year, your initial $1000 investment would have grown to over $116,000. The main reason for this high number is dividend reinvestment - if you had spent your dividend payments each year instead of reinvesting them into company stock your investment would have been worth only $51,000. In addition, if you had kept on reinvesting your quarterly dividend payments, your annual income would have increased to over $2,000 in 2007. Of course this sort of capital gains might not be replicated in the future but one thing is for sure – if the company keeps expanding and raising its dividend payment year in and year out, I would be its stockholder. It’s very nice to have your salary increased every year. That’s what dividend aristocrats like Pepsi provide to their shareholders in terms of payments.
Friday, January 25, 2008
Account Opening Bonus for OptionsXpress
Optionsxpress has a $100 bonus for new customers that open an account with them and deposit at least $500 by March 31, 2008. That's what their website says:
You need to have your account open for at least 6 months and your account balance should not fall below $500 unless you have trading losses.
http://www.optionsxpress.com/promos/free.aspx
Relevant Articles:
- Dividend Aristocrats List for 2009
- Dividend Aristocrats
- Best Dividends Stocks for the Long Run
- Best High Yield Dividend Stocks for 2009
- Best CD Rates
To receive $100 bonus, account must be funded with at least $500 cash or
securities transferred from a brokerage firm other than optionsXpress. $100
bonus will be deposited into the new optionsXpress account by April 30,
2008.
You need to have your account open for at least 6 months and your account balance should not fall below $500 unless you have trading losses.
http://www.optionsxpress.com/promos/free.aspx
Relevant Articles:
- Dividend Aristocrats List for 2009
- Dividend Aristocrats
- Best Dividends Stocks for the Long Run
- Best High Yield Dividend Stocks for 2009
- Best CD Rates
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