Options: A Powerful Instrument for High Stock Market Returns
It is said that stock market investing in a well-diversified portfolio will, over many years, outperform other forms of investments. History has shown this to be mostly true but it becomes a question of how much appreciation is achieved. You can speed up this appreciation process with the use of a simple trading technique used by many in the stock market. This is the use of options in your stock positions. There are two ways that options enhance stock market returns, by increasing dividend yields and by boosting the rate of stock value appreciation.
Boost Dividend Payments
For those invested in dividend-paying stocks, the strategy described here would definitely help in increasing revenues from your stock holdings. Many stock investors rely on cash dividends as a source of income. With dividend returns in the region of 3% to 6% annually, it is really not a great return for someone depending on this revenue source as supplemental income. This is fine for those who have millions invested in stocks but this can be disappointing for those not in the millions club.
Oh sure, there are many companies out there producing high dividend yields in excess of 15%-20%. But how safe are those? As the saying goes, the higher the return the greater the risk. I had a friend who hyped and bragged about his investment in an oil company stock that paid monthly dividends that worked out to an annual return of over 20%. His dividends went on nicely for as long as the crude oil boom lasted. When the boom went bust so did the company and all his investment. So when we talk of dividend-paying companies let us confine ourselves to those companies that have been around for many years and will be around for many more years to come. These are the companies that will allow you to sleep well at night but unfortunately do not pay out outstanding dividends. The solution to achieving higher dividend returns from these companies is the use of stock options.
Stock Options: Aren't They Risky?
I can hear the voices of thousands of naysayers: "Don't get involved with stock options. They're poison. Stock options are one of the worse investment solutions". Continue reading and make your own judgment. See proof of what I'm saying. You will be convinced this is not a bunch of BS. There definitely is something here that you should explore further.
Investing directly in stocks, as most stock investors do, limit the investor's ability to profit only in one direction. He/she profits when the stock moves up and loses when the stock moves down. If the stock remains stagnant he/she neither wins nor loses so the investment is, so to speak, asleep and not producing returns. With options, either alone or in conjunction with stocks, the investor is presented with a dizzying array of investment choices.
How Does Trading Options Produce Higher Returns?
By using a combination of covered call and covered put options you can easily and safely enjoy increased stock appreciation and high dividends from your stocks. When you combine the element of stock appreciation plus the stock's regular dividends plus option income, you are looking at achieving incredible returns. The table below illustrates some magic numbers.
The Basic Trading Technique Is the Selling of Calls and Puts
The strategy is better known as Covered Option Writing. You sell calls against the stock you already own and this trading strategy is known as Covered Call Writing or Covered Call Selling. If you don’t own stock but have cash parked in your broker account while waiting for an opportunity to invest, you can make that cash work for you by selling puts against it. This is what is called Covered Put Writing or Covered Put Selling. Put selling is ideal for one who is watching a stock with the intention of buying into it but patiently waiting for the price to drop to a lower level.
Risky? No, if you know what you are doing. This investing technique is no riskier than owning the stock and just letting it sleep. As a matter of fact, it is a technique that lessens the risk of owning stocks. Covered call writing has been compared to a person owning a piece of real estate and renting it out to generate income. In a sense, writing calls against your stock is like renting out your stock to generate income. In many cases, the stock you are holding is not moving much up or down so it really is not doing you any good. But selling calls against it generates income.
Go back to the table above and see how options enhance the returns on the selected stocks and produce high dividends. These are not isolated examples. In all cases where options are used in an investment of stocks or cash, the yields will always be much better than without options.
The companies chosen for this illustration are those that are well-known to stock investors and have been around for many years.
In calculating the Return on Investment, or ROI, dividends are added to stock price appreciation (Dec 2016 less Jan 2015) and the result is divided by the original stock price to arrive at the column “2-yr ROI w/Div Only”. In the last column, options sold are added to the total dividends and price appreciation (2016 less 2015) and again divided by the original price. The ROIs shown in the table are for a two year period, Jan 2015 to Dec 2016. The two year period was chosen in order to better average out the results. The longer the period the better the numbers.
Analyzing The Numbers
Let’s look at some of the companies on the list. In January of 2015, Bank of America (BAC) was trading at around 16.98. During the two year period to December 2016, it paid dividends eight times totaling $0.45. Its stock price in December was 22.10 which resulted in a price appreciation of $5.12. This price gain coupled with the $0.45 in dividends delivered a total gain of $5.57 which when divided by the original investment (January price) of 16.98 gave a total yield of 32.8% rounded off to 33%. This is strictly appreciation growth plus dividends, no options were sold.
If the investor had traded options during the same two years he would have added another 4.75 of cash revenues from the sales of calls and puts. This added revenue increased his total yield to a whopping 61% as shown in the last column.
See what selling options can do? That’s not something a stock investor seeking growth and high dividends should ignore.
Risk? Zero. Zip. Nada. By this I mean no more risk than owning the stock itself. I’ll demonstrate this with Ralph Lauren Corporation (RL).
In the table above if you had invested in RL in January 2015 you would have paid 175.99 per share. This is your original capital invested. After holding the stock for two years with the hope that it will eventually rise and allow you to make money on your investment, the stock was at 90.32 putting you in the hole by 85.67. In the two years, you held the stock you received a measly amount of $4.00 in cash dividends. Your total loss was 46% with dividends factored in. But if you had sold calls and puts while the stock went on its downward spiral you could have generated about $28 in cash revenues, thus reducing your total loss to around 30% instead of 46%.
By the above example, I’ve demonstrated that trading stocks alone is a riskier proposition than trading stocks coupled with selling options. In the Ralph Lauren case options enabled the investor to reduce his loss significantly.
Now that I've shown what options can do to stock investments should you still run for the exits when you hear the word 'stock options'? Perhaps it's now time to throw away your inhibitions about stock options and move forward towards learning this investment tool.
If you're new to stock options there are dozens of books on this subject in Amazon and other online bookstores both in paperback and Kindle versions.
This book was written specifically with the stock investor in mind. It shows the stock investor how to boost his investment returns with the use of options as a catalyst to his trading.
© 2018 Daniel Mollat