As I mentioned last time, my colleague Phil Lamanna and I believe that “10% Trades” are one of the best ways to generate double-digit income from great companies.
In particular, we’re talking about an opportunity to capture 10%-plus annualized yields from stocks we wouldn’t mind holding for the long-haul — such as those with strong histories of increasing dividends year after year.
Names that come to mind are stocks like McDonald’s (MCD), Wal-Mart (WMT) and Pepsi (PEP).
[hana-code-insert name=’adsense-article’ /]As Dividend Champions, each of these stocks have showered shareholders with larger and larger dividend checks each and every year for at least the last 25 years in a row.But even after decades of dividend growth, anyone putting new money into these stocks today will capture less than 3.5% yields.
That’s because over time their share prices have essentially risen in lockstep with their dividends, keeping dividend yields suppressed.
This can be a problem if you’re already in or nearing retirement and you’re looking for safe, high income from established dividend growers.
But this is precisely where a “10% Trade” can come in handy…
In short, a “10% Trade” is a term Phil and I coined for a conservative income-generating technique that involves selling either a covered call or a put on a high-quality dividend growth stock.
The beauty of a “10% Trade” is that you could double… triple… or even quadruple your annualized yields from the very same stocks I mentioned above… and many more like them.
It’s a great way to boost the yield on stocks you already own… or to lower your cost basis on stocks you’d like to own.
Consider the “10% Trade” I just made with Pepsi…
Capturing an 11.5% to 16.6% Annualized Yield from Pepsi
I like buying proven dividend growth stocks at reasonable prices. So when Pepsi (PEP) shares pulled back as much as 3% yesterday I pulled the trigger.
I won’t go into detail now as to why I’m ok buying Pepsi at these prices or why I consider it a stock I could hold for the long-haul.
Instead, I’d rather show you how this “10% Trade” can play out over the next 9 weeks.
That way you can see for yourself how simple and safe these kinds of trades can be.
Let’s get started…
At around noon EST yesterday I bought 100 shares of Pepsi (PEP) for $79.08 per share and simultaneously sold the April 19, $80 covered calls for $1.25 per share.
Scenario #1: Pepsi stays under $80 by April 19
If Pepsi stays under $80 by April 19 I’ll get to keep the 100 shares I just bought.
I’ll also have received $125 in covered call income ($1.25 x 100 shares) and $57 in quarterly dividends ($0.57 x 100 shares).
The covered call income — known as a “premium” in options speak — was collected instantly yesterday. I’ll collect the dividend income on March 31.
After commissions, the premium and dividend income alone will have already reduced my cost basis to $78.04 per share — a 1.3% “discount” on my purchase price yesterday. This, by the way, is a great example of how a “10% Trade” can be safer than a conventional stock trade.
At the end of the day, if this scenario plays out I’ll be looking at a $161.27 profit.
That may sound like peanuts, but take a look at the percentages: I received an instant 1.6% yield for selling the covered call ($125 / $7,908) and I’ll get a 0.7% yield from the upcoming dividend ($57 / $7,908).
When I subtract out the commissions, I’m looking at a 2.0% return in 65 days.
That works out to an 11.5% annualized yield… from a safe stock like Pepsi.
That’s the power of a “10% Trade.”
Scenario #2: Pepsi climbs over $80 by April 19
If Pepsi climbs over $80 by April 19 my 100 shares will get sold (“called away”) at $80 per share.
In this scenario, not only will I get to keep the $125 in covered call income ($1.25 x 100 shares) and the $57 in quarterly dividends ($0.57 x 100 shares)… but I’ll also generate $92 in capital gains ($0.92 x 100 shares) in the process.
Again, this is another example of the safety of a “10% Trade”: I’m getting paid now in order to agree to sell my stock at a higher price than what I just bought it for.
In this scenario, after commissions I’ll be looking at a $233.28 profit.
From a percentage standpoint, this “10% Trade” will deliver an instant 1.6% yield for selling the covered call ($125 / $7,908)… a 0.7% yield from the upcoming dividend ($57 / $7,908)… and a 1.2% return from capital gains ($80 / $79.08).
After subtracting out the commissions, I’m looking at a 2.9% return in 65 days (just over 9 weeks).
That works out to a 16.6% annualized yield from Pepsi.
Bottom Line: Either way this “10% Trade” works out offers me the opportunity to generate a 10%-plus annualized yield from a world class dividend grower like Pepsi (PEP). If I get to keep my shares and compound my income, great. If I’m forced to sell Pepsi at a 16.6% annualized profit, no problem. This is why I’m such a fan of “10% Trades.”
Greg Patrick
TradesOfTheDay.com