Selling options on high-quality dividend growth stocks could be one of the safest ways to boost your investment income in the short-term.
I’m talking about generating relatively safe 10%-plus annualized yields from stocks like PepsiCo (PEP), Apple (AAPL), Cisco (CSCO), Starbucks (SBUX), Johnson & Johnson (JNJ), United Parcel Service (UPS), Microsoft (MSFT) and more.
You may have never considered selling options before… but if you’re looking to maximize your yield, and to do it safely, then you owe it to yourself to at least spend some time learning how all of this works.
With a carefully-selected trade, even shares of a low-yielding stock like Apple (0.59% dividend yield) or Microsoft (0.75%) could deliver double-digit annualized income over the next 12 months. That’s over 13X the yield that you’d collect if you simply relied on these stocks’ dividends alone.
In other words, income that would typically take 12 months to generate — if all you did was collect the dividend — can be generated in a fraction of the time when you sell an option.
Consider the option I sold this past Friday on shares of Aflac (AFL), a high-quality dividend growth stock that looks undervalued right now…
At the time I made my trade on August 27, Aflac was selling for around $57.25 per share and the January 21, 2022, $55 put options were going for around $2.25 per share.
My trade involved selling one of these puts.
By selling a put option, I’m giving the buyer of the option the right, but not the obligation, to sell me 100 shares of AFL at $55 per share (the “strike” price) anytime between now and January 21, 2022 (the contract “expiration” date).
In exchange for that opportunity, the buyer of the option is paying me $2.25 per share (the “premium”). There are two probable ways this trade will work out…
Scenario 1: Aflac falls below $55 by January 21, 2022
If AFL falls below $55 by January 21, the option may get exercised. If that happens, I’ll be obligated to buy 100 shares at $55 per share.
The biggest downside here is that I’ll be buying the stock at a price that’s higher than its market price. In other words, the stock will be trading BELOW $55… yet I’ll still be obligated to buy at $55.
This is a stumbling block for many investors, but it’s not for me. That’s because I ONLY make these trades with stocks that I believe are worth more than the price I’ll be obligated to pay. So I already know I’m getting a deal, even if I end up paying more than market price for it.
In exchange for this agreement, I was paid an instant $225 (100 shares X $2.25 per share).
This money was immediately deposited into my 401(k) retirement account, where I made the trade.
Taking this income into consideration, my cost-basis would drop to $52.75 per share ($55 – $2.25).
That’s an 8% discount to the $57.25 share price that Aflac was selling for at the time I made this trade. Since Aflac already looks cheap, the opportunity to own it at an additional 8% discount is very attractive.
Scenario 2: Aflac stays above $55 by January 21, 2022
If AFL stays above $55 by January 21, the contract will expire worthless and I’ll walk away with the $225 in income without even having to buy shares.
This works out to a 4.1% return on what my purchase obligation would have been ($2.25 / $55) in 147 days.
If I can repeat these results over the period of a year, I could generate a 10.2% yield from Aflac, a stock that has a dividend yield of just 2.3%. And again, I generate this double-digit annualized yield without even owning the stock.
The biggest downside in this scenario is that I’m capping my potential upside to “just” 10.2% annualized. For example, if AFL shares go on to rise to $70, I’ll miss out on $12.75 in capital gains ($70 – $57.25). I miss out because I could have simply bought shares outright at the market price of $57.25 and then sold later at $70. But because I’m not actually buying shares in this scenario — I’m selling a put option that goes on to expire — I can’t do that.
Again, this is an issue for many investors but it’s not for me. It’s a trade-off I’m happy to make: guaranteed safe, high-income that’s capped at 10.2% vs. unknown, potentially bigger returns. I’ll take a safe double-digit annualized yield any day!
Interested in making this trade? Here’s how…
Options contracts work in 100-share blocks, so to “cover” the put option you’ll be selling, you’ll have to have $5,500 in cash available in your brokerage account. This money will be set aside for the duration of the trade — you won’t have access to it. If the option gets exercised, this cash will be used to purchase 100 shares of Aflac at $55 per share.
To make the trade, “Sell to Open” one PUT option with the January 21, 2022 expiration date and the $55 strike price. Place a limit order using a price of $2.25 per share. Keep in mind, since share prices and options premiums are constantly changing, the numbers I’m using are approximate at the time I’m publishing this article. Just be aware that your setup may be more favorable (or less favorable) than mine, so adjust the strike and limit prices accordingly. Here’s what my screen looked like before placing the trade. Hopefully this helps.
Good luck!
Greg Patrick
IMPORTANT: When it comes to selling puts, I’ve developed eight rules that help me maximize my income while minimizing my potential risk.
I only sell a put option if:
- I want to own the underlying stock anyways (since there’s a chance I’ll be “put” shares)
- I’d be buying the stock at a reasonable price (typically fair value or better) if I am indeed “put” shares
- The strike price of the option I’m selling is At-The-Money (ATM) or Out-of-The-Money (OTM)
- I’m comfortable owning the stock for the long-haul in case the price drops significantly below my strike price
- I’m comfortable “letting the stock get away from me” if I don’t get “put” shares and the stock takes off
- My position-sizing makes sense if I’m “put” the shares (I like to keep position sizes around 5% of my portfolio to stay diversified)
- I can make the trade in a retirement account, such as my 401(k) or IRA (thisminimizes taxes and tax paperwork)
- I “secure” or “cover” my put sale by having the cash in my account (this cash covers my purchase obligation in case the contract gets exercised and I have to buy the underlying stock. I ONLY sell cash-secured puts, NEVER naked puts)
If you’re interested in learning more about my own put-selling strategy, I put together a video that goes into a little more detail and walks you through a couple trades I made with Starbucks (SBUX) for safe, high income: $760 in Seconds: How I Sell Put Options for Safe Passive Income
