Your Questions Answered (Important Video Included)
I'd say it's no stretch to call AT&T (NYSE: T) one of the more reliable dividend-growth and income investment stocks on the market. The large telecom has continually paid dividends for 100 years, and has consistently raised that dividend annually for the past 28 years.
Dividend growth is unlikely to abate, because AT&T dominates its market. It operates the largest 4G network - covering 275 million users. It also offers the largest international and domestic WI-FI coverage of any U.S. wireless carrier.
AT&T is, as you'd expect, big. It generates $130 billion in revenue annually. Size confers a degree of safety and also an economy of scale that can produce tremendous amounts of cash.
In fact, AT&T generated record cash of $39.2 billion from its operations last year.
When you generate big cash, you can return big cash to your shareholders. In 2012, AT&T repurchased 371 million shares, or roughly 6% of shares outstanding, for $12.8 billion. This year, management expects to buy back another 300 million shares worth $11 billion.
Of course, AT&T also returns big cash to its shareholders through its dividend. In 2012, it returned over $10.2 billion to shareholders. This year, AT&T investors will receive a generous $1.80 dividend per share, which produces a 5.10% yield.
A 5.10% yield is exceptional in this market, particularly considering the S&P 500 yields around 2% and the 10-year Treasury notes yield around 2.6%. When AT&T's size and safety are factored in, the yield becomes even more impressive because AT&T is such a low-risk income investment.
Even though it's a safe, high-yield investment, AT&T still offers exceptional return potential. In the past two years, the blue-chip telecom has generated a 40% total return.
But what if I told you that you could increase your income and yield on AT&T by 75% or more each year? And what if I told you that you could collect this extra income every few months in addition to your regular quarterly dividend?
I'm referring to an option strategy known as a covered call, which allows you to collect extra income from a conservative dividend stock like AT&T.
When I mention "options" to many investors, they instantly think of risky investments that are only for speculators.
Nothing could be further from the truth.
An option is simply a contract to buy or sell shares of a stock at an agreed upon price (the strike price) at a future date. Options can be used to control large blocks of stock for a small price. But they also can be used to earn income or reduce risk. Best of all, options are traded as easily as any exchange-traded stock.
With a covered-call strategy, you buy shares of a specific stock and then sell a call option on that same stock. By doing so, you agree to sell the position at a future date and price to another investor. In exchange for giving the other investor the right to purchase the shares at a future date and price, you earn a premium in the form of a one-time upfront payment - the extra income.
So how does a covered-call strategy work with AT&T?
First, you need to own at least 100 shares of an AT&T. I say that because 100 shares of stock equal one option contract. Once you own the 100 shares, you're ready to start generating extra income.
Now, let's create the income-generating scenario: AT&T trades at roughly $35.50, which produces the 5.10% yield. By selling one covered call contract against 100 shares of AT&T, you can earn an extra $23 every two months.
So every 60 days, you give yourself the potential to collect $52 against 100 shares of AT&T. Annually that equates to $312 of extra income. This strategy safely doubles, in fact almost triples, the dividend of the stock.
So by implementing a covered-call strategy, you've taken an already high-yield income investment, AT&T, and boosted your potential income to $4.92 per share from $1.80 a share and your yield to 13.8% from 5.10%.
Answering Your Questions about Covered Calls
Last week, more than 2500 people tuned in for my exclusive teleconference on covered calls. During this one hour investing seminar, I shared my single best strategy for earning extra income and a few picks for the next 12 months.
The unfortunate thing is that most individual investors - including those with lots of experience - overlook this unique strategy. That is why I arranged for this opportunity to show Strike Price readers how to earn extra income by using covered calls on blue chip stocks.
If you were unable to join me you for the live teleconference please check out my webinar from several weeks ago as it will give you a detailed, step-by-step account on how I use covered calls in the High Yield Trader service. I encourage you to watch a rebroadcast right now. Just click here: Covered Calls 101 - With MSFT and INTC.
I believe every income investor should be using covered calls to earn 2x - 3x the investment income from blue chip stocks. If you're like most of my readers, you may think that covered calls are either boring or complicated. My goal is to prove to you that this strategy could mean all the difference.
But I know that your time is valuable, and you may now be able to spend one hour watching my presentation. So what I'm going to do today is answer some of the most common questions that might help you understand this opportunity.
I recently retired, and I'm a conservative investor. Do you think covered calls are an appropriate strategy for someone like me?
Covered calls are the only option strategy available to use in retirement accounts. I think that alone speaks volumes as to how inherently conservative covered calls are as an investment strategy. I tell investors all the time, particularly retirees that there is no better way to consistently bring in income on a residual basis. Moreover, the strategy actually decreases volatility within a portfolio. It's a win-win for all investors, especially those who seek reliable, consistent income.
I would love to earn an 8 - 10% yield from my blue chip stocks. Is this really possible?
Yes! We started High Yield Trader as a way to help our readers earn more income. At minimum, our goal is to double the dividend in every shareholder-friendly, blue-chip company we add to the portfolio. Since the service started roughly six months ago, we've been able to double, triple, even quintuple the dividends on half of the holdings within the portfolio. So yes, it is possible. And most important, is that it's possible without taking huge risks.
How do I know which strike price to use for selling covered calls?
This is probably the most frequently asked question among investors new to covered calls. That's understandable because there is a huge range of choices available in an options chain. For someone new to covered calls it can be overwhelming.
Below is the options chain for Microsoft (Nasdaq: MSFT), one the stocks we discussed in the webinar and one of our High Yield Trader holdings.
As I'm writing this, MSFT is trading for $35.30.
So basically, the further out of the money the call options sold, the more room there is for the stock to go upwards, but the lower the premium received from the call options themselves.
Let me explain using the options chain below.
Right away, you will notice difference in color between the in-the-money (ITM) and out-of-the-money (OTM) options. Beige is ITM and white is OTM.
Basically, the closer you sell an option to the at-the-money strike - in our case the 35 calls are considered at-the-money - the less room there is for the stock to go upwards but the higher the premium received from the call options themselves.
The reason is because there is a greater chance for stock to close above the strike at expiration. Obviously, the further away we are able to sell our call strike the more margin for error and the greater the chance of success on the call sold.
Yes, there is no free lunch in options trading and options trading is all about trade-offs between profitability and risk. As such, your outlook on the performance of the stock is pivotal in deciding which strike price works best. If you expect the stock to go up significantly, you would write further out-of-the-money call options, while if you expect the stock to still go up only very slightly or not at all, you might decide to write just slightly out-of-the-money call options or even at-the-money call options. A popular method used in options trading is to sell the call options on the price at which you expect the stock to peak.
Within High Yield Trader we take the guessing out of the equation by selecting probabilities calls that are higher than 70% (as seen in the far left column). By using probabilities, we would sell the December 37 calls (77.23%) or the December 38 calls (86.77%).
Also, you have to consider transaction costs on the options you wish to sell. If they're only worth a nickel or a dime, they are probably not worth selling because of the transaction costs, so you have to go out longer in those cases to get enough premium to cover your transaction costs.
Which expiration cycle do I use to sell covered calls?
Unless you have a strong reason to do otherwise, the practice in options trading for covered calls is to sell the calls 1-2 months out as they expire fastest, putting time decay in your favor. Remember, we are selling our calls to speculators so the best-case scenario is to have our calls expire worthless. This means that will receive the max profit on the trade.
Again, I hope you have a chance to watch our latest webinar. It's a great primer to get you started using covered calls on some of the most shareholder-friendly, blue-chip companies available to investors. In fact, MSFT and INTC are two of our favorite candidates.
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