Hi everyone,
Here is a section talking about how options work from the DCL Capital monthly commentary. Our super fantastic Portfolio Manger, Gordon Higgins, describes the process of selling options on dividend stocks that you already love. In this market it’s crucial to collect dividend and option income. DCL Capital clients are up while the market is flat to date.
If you’d like to be put on our email list to receive the DCL Capital monthly commentary please email me at davidlester@dclcapital.com.
DCL Capital Option Income Portfolios
• 2 sources of income: dividends and by writing options
• Actively managed value-oriented portfolios
• Focused on large capitalization dividend paying Canadian and US companies
• Individually managed portfolios
• Tax preferred dividends and capital gains from option premiums
Options as an investment tool.
Options are often perceived as a risky way to increase leverage in an investment portfolio; however they can also be used to generate income.
First, what is an option? An option is a derivative that allows the owner to either buy (call
option) or sell (put option) a stock at a fixed price over a period of time. Warren Buffett
describes derivatives as weapons of capital destruction yet he invested in warrants, long term
options, when he bailed out some US banks.
How can you take a derivative and use it to generate income?
You can enhance the yield by collecting income from selling what is known as a covered call. A
covered call is a call you sell when you own the stock. For example, you buy 200 shares of a
stock and write (sell) a call option on 200 shares of the stock. When you sell the option you get
paid a premium from the purchaser. This is your income. What do you have to give up to earn
this income? When you sell an option you sell the right to purchase the stock for a fixed period
of time, say 2 months, at a fixed price. If the stock is trading at $20, you might get 50 cents in
premium but limit your upside on the stock to $23 for 2 months. If the stock price drops you
keep the 50 cents as income. If the price rises buts stays under $23 you keep the income. If the
price rises above $23 you could be forced to sell the stock at $23 but you also get the 50 cent
premium. This strategy works best in a flat or slowly moving market. If stocks have large
upward price moves you give up the opportunity for significant gains. Remember the concept
was to increase ongoing income so selling a stock at a higher price than you paid is not a bad
thing.
David Lester describes this as collecting rent in his book “I Money”. He views the dividend
income as the first rent and the option premiums as the second rent. He feels investors get paid to
hold stocks, if they have dividends and options.
This strategy is not for every investor but may help those looking for higher distributions from
stocks they already like.
