Comprehensive Analysis of US Dividend Stock Investment Strategies Part 4
Investing in dividend stocks is generally known as a method to pursue long-term and stable returns. However, with increasing volatility in the current stock market, it has become challenging to achieve the desired return rates with dividend income alone.
By utilizing options strategies like Covered Call and Covered Put, investors can add options premiums to dividend incomes, forming a complex return structure.
This article will delve into the fundamental concepts, advantages, disadvantages, synergy effects with dividend stocks, and important considerations when applying these two strategies. Through this analysis, we aim to present methods for investors to pursue more efficient returns.
U.S. Dividend Stocks and Covered Call ETF Investment Strategy Series
Covered Call Strategy: An Income Maximization Strategy Favorable for Dividend Stock Holders
The covered call strategy is a method of generating additional income by selling call options on the dividend stocks you hold.
By selling call options, investors receive premiums that provide cash flow, helping to enhance portfolio returns when the market is stagnant or mildly declining.
For example, an investor holding 100 shares of Verizon stock with a 4% dividend yield could generate an annual options premium in the single digits by selling a call option each month.
The covered call strategy has several advantages.
Firstly, it allows for additional income. Thanks to the call option premiums, returns increase beyond just dividends.
Secondly, it provides a level of protection against falling stock prices. The premiums help mitigate some of the losses caused by declining prices.
Lastly, it increases portfolio stability. With a portion of the returns being more fixed, market volatility decreases.
A covered call product has the disadvantage of having to give up excess returns if the stock price exceeds the exercise price of the call option during upward trends. If the call option is exercised, the stock will be forcibly sold, which can conflict with long-term holding strategies. Particularly, if the call option is exercised before the dividend is paid, there is a risk of early exercise that forces the sale of the stock before receiving the dividend.
Nonetheless, in cases where the market is stagnant or highly uncertain, the covered call strategy has become an effective means of providing stable cash flow. The representative covered call ETF, JEPI, records annual returns of 7-8% by combining dividend stock investments with call selling, earning it the nickname "salary-earning investment."
Due to these characteristics, the covered call strategy can be an attractive option for investors.
Covered Put Strategy: Using Cash for Cheap Purchases and Premium Income Simultaneously
The covered put strategy may be unfamiliar to many, but it can be a useful approach for those investing in dividend stocks. However, to effectively utilize this strategy, a clear understanding of related terms must precede it. Generally, when investors mention covered puts, they often refer to the 'Cash-Secured Put' strategy. Hence, familiarizing oneself with this concept is crucial.
‘Covered Put’ is a high-risk strategy that involves selling put options on short-sold stocks, aiming for profit when stock prices decline. In contrast, the strategy we will examine uses cash as collateral to sell put options in a 'Cash-Secured Put'. This approach is a low-risk strategy aimed at buying dividend stocks at a lower price while generating additional income through options premiums.
Since many investors and research materials refer to this strategy as a covered put, the terms will be used interchangeably in this text. Through this strategy, we aim to present methods for pursuing stable returns and preparing for market volatility.
In summary, the cash-secured put strategy is useful for investors wanting to buy desired dividend stocks below the current price.
This strategy involves selling puts without holding the underlying stocks, while preparing funds for purchase in case the option is exercised. This method is particularly effective when the stock is not expected to rise significantly in short term and is anticipated to move within a certain range.
The covered put strategy has several advantages. Firstly, it provides investors with the opportunity to purchase stable dividend stocks at discounted prices. Secondly, even if the stocks are not purchased, cash income can be secured through options premiums. Thirdly, it offers a systematic entry strategy that allows for purchasing at low prices based on certain rules.
For instance, if an investor wants to buy a dividend stock currently priced at $50 for $45, they sell a put option with a $45 exercise price and receive a $1 premium. If the stock price falls and the option is exercised, it will be equivalent to buying the stock at $44, after which dividends can be received from the stock. Conversely, if the stock price rises, although the stock cannot be purchased, compensation can be received through the premium income. For these reasons, the covered put strategy is considered an attractive investment method.
The disadvantage is that if a larger than expected decline occurs, there is a risk of having to buy the stock at a price significantly above the desired level. Additionally, in cases of a sharp price increase, there may be an opportunity cost of missing out on purchasing promising stocks.
This approach helps to implement a systematic and emotion-free entry strategy for dividend stocks that one wishes to hold long-term. By selecting dividend aristocrats or stable high-dividend stocks, the expected return on risk can be improved.
Covered Call + Covered Put: A Composite Income Model Combining Dividends and Premiums through the Wheel Strategy
The Wheel strategy is an effective method for enhancing portfolio profitability and acquiring flexibility by alternately using covered calls and covered puts.
The strategy begins with selling a covered put, and when the option is exercised, the stock is purchased. Afterwards, covered calls are sold on the held stock, followed by selling the stock and repeating the process with covered puts. Through this cyclical process, continuous income can be generated.
This strategy combines dividend income and options premiums, effectively managing assets while maintaining low risk.
However, it is advisable to avoid this method if there are potential financial risks or the possibility of dividend cuts associated with certain stocks.
Additionally, the exercise price and expiration date of options should be adjusted carefully according to individual investment goals.
Enhancing Cash Flow and Risk Management Ability with Options Strategies Added to Dividend Investing
Covered call and covered put strategies serve as useful tools that add supplemental income and risk management capabilities to simple dividend investing.
Covered calls act by enhancing returns through premiums on held stocks, while covered puts provide opportunities to buy desired stocks at lower prices.
These two strategies capitalize on their advantages in both rising and falling markets, allowing investors to flexibly combine strategies according to market conditions.
Strategies utilizing options involve several risk factors, including failed price predictions, risks of sudden increases or decreases, and situations involving early exercise. Therefore, it is crucial to conduct thorough analysis of stocks and establish clear risk tolerance levels when using options.
In particular, investors who prioritize dividend income should consider the impact of premium income on dividends in advance. Designing option strategies in a stable and repeatable structure, rather than overly aggressive tactics, is more desirable. This allows for minimizing risk while pursuing stable returns.
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