With the dividend yield of the S&P 500 well below the historical average, finding stocks that sport both a high yield and a safe dividend isn’t as easy as it used to be. Luckily, there is a fairly conservative way to boost the income generated from your portfolio by selling call options. The premium received using this method can easily double your dividend yield even for big, blue-chip stocks. Here are three examples of dividend boosts that can be achieved by selling call options.
The Procter & Gamble Company (NYSE:PG)
The Procter & Gamble Company (NYSE:PG) is a $200 billion consumer goods company that owns well-known brands such as Gillette, CoverGirl, Duracell, Charmin, Pampers, and countless more. The stock currently yields about 2.9%. Since 2003, the dividend has grown at an annualized rate of about 11%.
The stock has run up significantly in 2013, almost 13% in just a few months, and from it’s 52-week low in June of last year the stock has increased by nearly 30%. At the time of that low the dividend yield was 3.8%, almost a percentage point higher than the yield today. Selling call options can bring the effective yield back to or even higher than that level.
With the stock currently trading at around $76.60, an $80 strike price would offer a 4.4% buffer against the option being exercised. This means that the stock would need to rise by 4.4% before the call option becomes in-the-money and the shares become at risk of being called away.
The other component of the option is the expiration date. The longer the time until expiration the greater the chance that the stock price rises above the strike price, so we’ll want to stick to fairly short-term options. Of course, the shorter-term the option the lower the premium, so there’s a balance between safety and premium.
The June $80 call option looks like it achieves that balance. The premium of around $0.53/contract/share leads to an annualized yield of 2.75%, which when added to the current dividend yield brings the total effective yield to 5.65%.
If greater safety is required then the June $82.50 call option has a larger buffer of 7.7%. With this larger buffer comes a reduction of the premium to $0.18/contract/share, which knocks the total effective yield down to 3.8%. This, however, brings the yield back to the level last seen at the 52-week low.
Chevron Corporation (NYSE:CVX)
Chevron Corporation (NYSE:CVX) is one of the major integrated energy companies with a market capitalization of $230 billion. I called Chevron Corporation (NYSE:CVX) the best big oil stock in a previous article when the stock was trading at about $115 per share. Since then, the stock has risen by a little more than 4%, bringing the dividend yield down just below 3%. Chevron Corporation (NYSE:CVX) has grown its dividend at an annualized rate of 6.77% over the past 5 years, but has recently picked up that pace with an 11% increase in the beginning of 2012. Using call options, the yield can be increased even further without waiting for the company to increase the dividend.
The June $125 call option has a strike price about 4.2% above the current stock price and a premium of $0.94/contract/share. This premium creates an annualized yield of 3.12%, which when added to the current dividend gives a total effective yield of 6.09%. This is more than double the current yield.
Because the June $130 call option looks unappealing, the September $130 is a better choice if more safety is required. The premium of $0.95/contract/share represents an annualized yield of 1.49%, or an effective total yield of 4.46%. Although this yield is lower than that of the previous option, the buffer is larger at 8.3%.
Wal-Mart Stores, Inc. (NYSE:WMT)
For being one of the largest companies in the world Wal-Mart Stores, Inc. (NYSE:WMT) has never paid a particularly exciting dividend. After rising slowly over the past decade, the yield currently stands at 2.53%.
WMT Dividend Yield data by YCharts
Wal-Mart Stores, Inc. (NYSE:WMT)’s payout ratio (using free cash flow) is about 50%, meaning that the dividend growth will come mainly from earnings growth in the future. Given that this is a company which already does $469 billion in annual sales, I think growth is likely to be slower than in the past. With a lower yield than the other two companies I’ve discussed and expectations of slow dividend growth, Wal-Mart Stores, Inc. (NYSE:WMT) is not an ideal dividend stock. But selling call options can change that.
The June $77.50 call option has a buffer of 3.5% above the current share price while offering a premium of $0.72/contract/share. This premium represents an annualized yield of 3.85%, or when added to the current dividend an effective total yield of 6.38%. This is 2.5 times higher than the dividend yield alone and higher than any of the cases considered above.
A larger buffer of 6.9% is offered by the September $80 call option. The premium here is $0.76/contract/share for an annualized yield of 1.94%. Added to the current dividend this gives an effective total yield of 4.47%.
The bottom line
By selling call options, one can greatly increase the income generated from a position. In many cases, even high-quality dividend stocks can have their effective yields doubled by selling call options.
The biggest risk with this strategy is that your shares can be called away if the stock price appreciates too much. Because of this, it is best to sell call options on stocks which have already appreciated since purchase and which are at a level at which you would be comfortable selling. This minimizes the negative effect of having your shares called away at less than the market price.
The article Using Options to Increase Your Dividends originally appeared on Fool.com and is written by Timothy Green.
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