A Different Kind of Income Strategy

Image for income strategy

There are two main types of people in the world — introverts or extroverts. Some of us are a little of both, but for the most part, we fall into one category or another.

Same is true in the investing world. There are two main types of investors that almost all of us can be classified by. We have those who look for shoot-the-moon opportunities, which rarely come true. Then there are those of us who look for stable and consistent growth, where we can accumulate our returns over time.

If you’re a shoot-the-moon type of investor, then you probably don’t want to hear about this income strategy.

But, if you’re the second type of investor, you will want to hear about this income strategy — a simple way to generate an extra 20% yield from a portfolio. This is something you could be implementing in every portfolio you own.

If you’re building a stable and steady portfolio, you’re going about growing your wealth the right way. You probably have several blue-chip stocks sitting in it that have been around for decades and generate a steady yield.

That’s because these blue chips offer relatively safe and stable returns.

With them, you generate some income, and you feel pretty confident the company will be around in 20 to 30 years, so you don’t mind owning its stock.

But what you may not know is that there is an easy and reliable way to generate extra income from these exact stocks — income you are currently leaving on the table if you are not using this simple income strategy … covered call options.

A Different Income Strategy

Most people buy call options as a way to generate robust returns — this is how the shoot-the-moon type of investors use them. A call option contract gives the buyer the right to buy the shares of a company at a predetermined price by a predetermined date.

But what few people realize is that if you own the stock — specifically, these large, steady blue-chip stocks — you can sell a call option, known as a covered call, above the stock’s current price to collect additional income.

It’s that simple.

Once your order is executed, the money is deposited into your account and you are free to do whatever you want with it.

The amount you collect can vary, but the key thing to focus on is that you are selling your covered call option at a price you are comfortable selling your shares at. If the price of the stock rises above your strike price by option expiration, you will be obligated to sell your shares at that strike price.

You still keep the income you collected, so I’m always perfectly fine with my stock being sold, or “called away,” in option-trading lingo.

Here, let me walk you through a real-time example, one you can actually use today if you are holding shares of General Electric (NYSE: GE).

Generate Extra Income With Covered Call Options

Let’s say you own several hundred shares of General Electric in your portfolio. The stock generally doesn’t move more than 10% in basically a five- to six-month time frame. Today, GE is trading around $30, but it has rallied 24% in the past two months.

This tells me now may be an ideal time to collect income as the shares take a breather from their recent rally.

A covered call is an agreement to sell 100 shares of the underlying stock you currently hold at a predetermined price for every option contract you sell.

For example, if you own 200 shares, you can sell two call option contracts. If you own an odd number of shares, just round to the lowest hundred to figure out how many call options to sell.

In the case for GE, you could sell the $31-strike February 2016 call options (GE160219C00031000) and immediately collect $0.85, or about 2.7% based on the price above.

That is your instant yield just by agreeing to hold the stock for three more months and being willing to sell your shares for $31 — 1.6% above GE’s current price. Not to mention the 3% dividend yield you pick up along the way.

Including the dividends, you would collect a 5.9% yield based on the stock’s current price, and that’s in just over two months.

That’s a 27.9% yield on an annualized basis!

With covered calls, there is a chance your shares may be called away from time to time should the stock price climb above the strike price, but you can just jump right back in if that happens. Either way you keep the option premium you collected, so your income doesn’t change.

What’s more, you can use the same short put option strategy I use in Pure Income and generate even more yield from the stocks you already own, or want to own, in your portfolio.

Even though finding a decent income stream these days seems challenging, it is something I deliver week in and week out using the strategy I outlined above, along with selling put options.

There may be a war against savers with the Fed’s continued ultra-low interest rates, but it doesn’t mean you have to wave a white flag.

Image for income strategy
Chad Shoop
Editor, Pure Income