Dividend Stock or Covered Call Stocks? (How do I decide?)A few months ago I wrote an article about how to turn an non-dividend paying stock into a dividend paying one by using covered calls. You buy 100 shares of a stock, collect money up front and take on the obligation to sell the stock at some point in the future for a set price. This price is set, even if the market is offering more. I started to do this with a few stocks I already owned such as Pfizer, AT&T, and Walmart. The problem with this (for me) was they are also great dividend stocks, and I didn’t want to lose out on those either compared to the small premiums I was receiving. In other words, these are stocks I don’t really want to sell. Therefore, these fall into my “Buy & Hold” category. Unfortunately for me, I ended up buying back my calls at a price higher than the initial premium I received for them. This is bad. Lucky for me, I still had a lower cost basis than what I paid for the stock, but it wasn’t fun to realize late in the game. Moving forward, I’m going to do a buy-write which is the purchase of 100 shares and the selling of a covered call at the same time. This hopefully will help get me in the right mindset. In other words, thinking of the stock as kind of tool for generating extra income. So, if I get to keep the stock along the way because the initial strike price wasn’t met, that’s great, and I’ll do it again. Or, if I end up having to sell the stock because it exceeded the strike price, I’m OK with that as well! This is because I chose the stock based on a different criteria than I would for a high-paying dividend stock. The big lessons learned are the specific criteria for me to utilize a stock for a covered call action. For me, I outline the following criteria for a covered call stock: 1. Pick a stock you don’t mind selling – do not get married to your stocks or become emotionally attached to them in any way. When you you sell a covered call, you take on an obligation to sell the stock at a later date. Some options traders discover they can’t part with the stock and it becomes painful to say goodbye. Don’t let this happen to you! 2. Chose a Stock that isn’t too Volatile – While volatile stocks provide more risk and greater premium, they can also backfire when attempting to execute a covered call. For example, when I tried my first covered call, it was on SNAP and that stock was too volatile for me. Therefore rather than going up, it started to go way down, and I didn’t have the patience to continue watching it lose money. I took a loss, even with the premium lowering my cost basis. 3. Chose a stock that has a neutral to mildly bullish sentiment – When looking for a stock to use for a covered call, you really don’t want one that will go parabolic or one that will drop, you want one that doesn’t really seem to go anywhere while you’re holding it, or up a few dollars. If it doesn’t hit the strike price, you don’t mind holding, and if it exceeds the strike price, you don’t mind selling. Either way you will profit if the stock stays above your break even price (Stock Price – Premium Received). 4. Get Good Premium – If you don’t collect enough premium and it’s time to sell above the strike price, you might be kicking yourself that you could have made more money buying and holding the stock outright. Get enough premium up front that it’s worth your time and effort. 5. Try to hold the covered call over the the ex-dividend date so you receive the dividend. Note the option buyer on the other side may know this, so your premium might be lower than usual. 6. Know your Break Even Point – This is the total amount you spend out of pocket for 100 shares minus the premium. Consider what you would do if the stock went below it. Would you sell? Would you hold? Know how much you’re willing to lose, and don’t take on more risk than you are comfortable with. So this has been my journey thus far. This is now some of the criteria I am using to analyze whether for me something is a buy/hold dividend stock or a “tool” to use as a covered call trade.
- AS ALWAYS, THIS IS NOT ADVICE TO ANYONE. THE VIEWS EXPRESSED ARE PERSONAL OPINIONS. INVESTING IS INHERENTLY RISKY. SEE A FIDUCIARY FINANCIAL PROFESSIONAL.