In our series on simple stock investing methods, we take a closer look at approaches that are brought to our attention by our readers and members. This time we look at the approach of owning high dividend stocks and combine them with writing Call Options on these same stocks.

Some investors aim to achieve an annual return of 10% to 15% by owning high dividend stocks while writing Call Options on these stocks. This is something that you can do as well. In this page we will explain how it works and what risks one should be aware of.

What is it?
 

• You buy stocks of companies that pay dividends that are higher than 5% of the stock price on an annual basis.
   
• You can find these companies by checking the fundamental analysis for stocks that many financial sites are publishing and updating.
   
• When owning these stocks, you write Call Options on these stocks that have an execution price that is about 10% above the current stock price and that expire in 1 or 2 months.
   
• You could have a target to earn on these Call Options about 1% of the invested capital in the corresponding stocks for every time that you write them.
   
• Your overall target could be to make in total a return of 10% to 15% annually from the combination of dividends and proceeds of the Call Options.  
   

How does it work?
 

• When you write a Call Option, you will receive a fee for that.
   
• When the stock price does not increase above the execution price of the option before the expiration date of the option, the option expires without being executed and you can pocket the fee you have received (minus the costs for your broker) as profit.
   
• When the stock price does increase to above the execution price of the option before the expiration date of the option, you are obliged to sell your stocks for this execution price. You make profit on your stocks between your purchase price and the execution price, but you will not have any profits for the stock price increasing beyond the execution price. And you can keep the fee you received for writing the Call Option.
   
• The fee you receive for writing the Call Option is higher when the execution price is lower.  Thus the higher the fee that you receive the more risk you take that you have to sell your stocks for the lower execution price.

What to take into account?
 

• First of all, this is not for everyone. You need to have a very good understanding how Options work before trading in them. Options have a high-risk and it is easy to lose all your money that you have invested in Options. Make sure that you have a solid education and understanding of how to handle Options before trading in them. Just reading this page is not enough.
   
• If the stock price increases to above the execution price, you have a choice to sell your stocks for the execution price and stop using this approach for that stock or to buy the stock again for the current higher market price and continue the approach as before. Note that you missed the gains from the increase of the stock price between the execution price and the current market price.
   
• If the stock price falls compared to the moment that you wrote the Call Option, you have received your fee from the Option, but you also own stock now that is less worth than it was before. The losses you make on holding the stock can be much bigger than the fee you receive from writing the Call Option.
   

Our Conclusion on High Dividend Funds and Call Options
 

• This approach is suitable when markets move side-wards or slowly up.
   
• Avoid this approach with stocks of less than rock-solid companies or during times that the trend points down. Losses in the stock price will exceed the received fees from writing the Options.
   
• If you use the approach, really do your homework to select the rock-solid companies.
   
• Use this approach only for a part of your investments when markets are moving up strongly. You could otherwise miss the gains of strong advances in the stock price.

Just an idea: to avoid the homework to select rock-solid companies, could you apply this approach on high dividend mutual or index funds?

 

Please share your experiences with this approach and which stocks you are using for it by commenting on this page or sending us your input via the contact form.

When you use another simple investing approach that you like to share with our readers and on which you like to have their and our comments, please send us your ideas.