Showing posts with label Covered call strategy. Show all posts
Showing posts with label Covered call strategy. Show all posts

Wednesday, April 1, 2020

What should retirees do?

  • Understand impact of crisis from Government printing trillions upon trillions of dollars
  • Adjust investment plan to tilt toward income growth
  • Use dividend stocks with dividend growth history over bonds 
  • Employ a covered call strategy on selected dividend stocks

Most of us are income investors who also know in the best of times the need for more income in the future is expected.  Good financial planning means you include this goal when picking your investments.

We will get over the Corona Virus impact but as James Mackintosh said in the Wall Street Journal:  "There'll be debt to pay after crisis."

What will cause problems for us?

  • Government just printed 2 Trillion Dollars
  • With more and more dollars out there, those we have are worth less
  • In addition we have cut down on making things
  • We will have to spend more of our dollars buying scarcer goods whose prices will probably rise. 

This is not a difficult scenario to swallow.  There may be pockets such as energy that will not respond in this way.  "Stuff" however will cost more.  If you believe in this scenario then the question is:

What to do.

  • Buy as many scarce goods as you can
  • Accumulate more dollars as you will need them to live on
  • Stimulate increasing supply to get supply to catch up

In our society, a capitalist society equilibrium will win, but that takes time.  And the individual investor has little influence on stimulating the supply chain for "Stuff."  We could hoard goods to hedge against increasing prices.  We could go back to work to accumulate more dollars to put to work so we can afford rising prices.

When you can't go to work, your money goes to work.  Bonds have been a safe haven but are not a good investment.  Safe Bond yields at half of a percent make you think of buying higher risk bonds and those carry a good chance of losing value.

Stocks with dividends and a history of dividend growth are a better way to earn the 3 or more percent yield you need.  You know 3% on a million dollar portfolio is only $30,000 per year.

Real estate is an investment class of its own.  Ordinary retired investors use REIT stocks as a proxy for owning real estate and indeed REIT's provide a lot of yield.  REIT's are complex; you need to know what  you are doing.

Another source of income for ordinary investors is to sell, also known as write, calls on stocks you own.  This is a bit complex but not that difficult if you follow some guidelines.

I posit the best investment for retirees who want income to grow and want more than just 3-4% is dividend stocks with a covered call strategy.  I cannot reinforce this enough.  I make my income off of dividends and covered call premium income on those dividend stocks.  You can easily increase your 3-4% by another 1-3% by employing this strategy.

Never before have dividend stocks been so cheap.  The market will continue to bump along the bottom while we work through the crises.  Quality dividend stocks are available.  Here is what I look for:

  • Dividend yield 2.5% or more
  • 3 Yr Dividend growth rate 4% or more
  • Optionable
  • P/E ratio (trailing) 15 or less
  • D/E (debt to equity ratio) 1 or less
  • No dividend reduction if paying a dividend in 2008

Let's look at an example available today.

Intel, symbol INTC, is a common holding in a conservative investor's portfolio.  I certainly have been in and out of Intel for years.  My previous cost basis is in the mid teens.  As INTC corrected recently, I nibbled at around $56.  That was about 19% below the recent high of $69.29.  Intel corrected even more and those shares are under water.  Today INTC is trading around $53.00- $54.00

The table below shows the quality of Intel's fundamentals.  Notice that earnings and P/E ratios are based on trailing earnings.  Intel's P/E ratio is 10.99.  We do not know how earnings will be affected by this crisis so P/E's will change.

I call this a quality company because even if earnings are cut in half, they can still cover the dividend.  With a D/E ratio of only .37.  I think the dividend is quite safe.  

One of the most important pieces to building a portfolio for retirement is to have about 35 stocks and to have enough of a position in a stock that you can work covered calls.

INTC Annual EPS Annual Div
  Earnings>Dividend $4.78 $1.32
  Debt to Equity Ratio 0.37
  Dividend Yield 2.47%
  3 Yr. Rev. Growth 7.22%
  3 Yr. Div. Growth 8.90%
  Cash Flow/Share $7.41

But, and it is a big but, living on a dividend yield of 2.47% is not easy.  One would have hoped that with the price correction, the yield would be higher.  On the other hand, I like the quality of the fundamentals enough that I can swallow having this name in my portfolio.

I sold a call today on those new shares.  I picked a strike price of $60 so if I am called away, I make capital gains.  If I am not called away, I pocket the premium.

I picked an expiration date after the next ex-dividend date which is May 6, 2020.  Provided my shares are not called away before the next ex-dividend date, I get to pocket the dividend and the premium.

Using my Cost Basis Price on Open Call Expiration 
INTC $53.44 5/6/2020
Cost Basis:   12/3/2019 $56.00
Strike Price: $60.00
Call Premium:  $1.25
Dividend  5/6/2020 $0.330
Call Yield on Basis 2.23%
Call + Dividend Yield on Basis 2.82%
$ Gain if Assigned $5.58
Max Return  if Assigned 9.96%

Basis is price on open Price on Open Call Expiration 
INTC $53.44 5/6/2020
Cost Basis:   Price on Option Contract Open $53.44
Strike Price: $60.00
Call Premium:  $1.25
Dividend  5/6/2020 $0.330
Call Yield on Basis 2.34%
Call + Dividend Yield on Basis 2.96%
$ Gain if Assigned $8.14
Max Return  if Assigned 15.23%

Looking at INTC's fundamentals, I am willing to risk not losing the shares even though I am underwater for now because I am adding a quality stock with low debt and a reasonable dividend yield.

Of course all this data will change over the coming months.  But even if earnings are cut in half, INTC should still be able to maintain the dividend.  Even between 2008 and 2009 INTC was able to increase their dividend 3.2% while earnings were cut by 16% during the same time frame. When I received that $1.25 premium, that is equivalent to three extra dividends.  

If I hold Intel through a full year, and sell only this one call, my income yield on the $53.44 is up to 4.7%.  Now that is an investment I can live on.  Just think how you can milk your stocks by doing more than 1 call per year.  With multiple lots (you must have 100 shares to sell one option contract) you can roll the expiration dates as the market provides opportunities.

With the market so very volatile, there is no way to tell how this trade will unfold;  let's just see what happens.

You have to do your work.  On my first screen I found 81 stocks, but then on closer inspection I found maybe 10 stocks where I could work this strategy.  I wrote up Intel because it is such a quality stock to add on weakness or to start a position and because I have had such success selling calls.

M* MoneyMadam
Disclosure:  Long INTC with calls

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