How To Get High Payouts From Low-Yield Tech
In my last article, I cautioned against ignoring small/mid-cap tech stocks. Even in a conservative portfolio focused on income, it makes sense for diversification purposes – plus, the growth potential is sometimes just too good to pass up.
Still, while capital returns are becoming more of a focus, tech companies generally plow the lion’s share of their cash into expansion projects, new product development, and other growth-minded pursuits. That balance keeps yields in check (payouts of 1% to 2% are common).
Is there a way to harness the capital appreciation of this group while still pocketing more income? You bet. And today, I want to discuss how we can do that by using a simple, but effective strategy: selling covered call options. Don’t be scared by the terminology. It’s really quite easy to learn.
How They Work
Let me explain using a holding in our own High-Yield Investing portfolio, Seagate (NYSE: STX). The storage device maker is currently trading around $47 per share and offers a respectable yield of 5.5%. Suppose I am bullish long-term but think the stock might have trouble making any headway the next few months.
One way to mitigate risk — and generate extra income at the same time — is by selling a covered call option. These contracts convey the right (but not the obligation) for one investor to purchase stock from another at a pre-designated price. In this case, there is a call option on STX expiring in December with a strike price of $55.
The cost (or premium) is $1.00 per share. Since each contract involves 100 shares, this one would cost $100. As the seller, I would collect that cash from the buyer upfront. In turn, they have the right to buy 100 shares of STX from me at $55 per share.
If STX fails to reach that level, then the contract expires. I will happily pocket an extra $100 in income for my trouble and move on. That might not sound like much. But by itself, $1.00 on a $47 stock represents an income stream of 2.1%. And that’s just for a 3-month holding period. After the contract expires in December, I could immediately sell a second call option for another 3-month period, and then possibly another.
The longer STX stays below $55, the more income I can harvest. Repeating this strategy four times over the next year would bring in $4.00 per share in premium income, or 8.4%. Of course, I would also still collect the regular dividend yield of 5.5% along the way.
Now that’s making your money work harder.
What happens if STX moves sharply higher and climbs above the $55 strike price? Well, I wouldn’t complain about that scenario either. After all, that would represent a healthy 17% gain from the current price – and I’d still keep the $100 premium income as a parting gift.
What’s the catch? Well, I would have to sell my STX shares at the agreed-upon price and forgo any additional upside beyond that. But that might be a fair tradeoff, particularly in a market that is showing signs of topping out.
Dividend investing is a waiting game anyway. We buy with the intent of getting a paycheck every quarter and hopefully selling the stock in the future at a higher price. If the stock reaches that target price quickly, great. If not, then writing call options offers another way to collect more income while you wait.
The goal of this strategy is to earn supplemental income during periods when the market (or an individual stock) isn’t going anywhere fast. Utilizing options is a bit like “renting” a stock out for a while to make a few extra bucks. And contrary to popular belief, these call options aren’t risky. Actually, they reduce your downside exposure.
If 100 shares of STX can generate about $400 in yearly premium income, then 1,000 shares can give us $4,000 and 10,000 shares can net $40,000. So, imagine the income potential for a fund that holds hundreds of thousands (or even millions) of shares.
Now, anybody can do this on their own. But my latest recommendation over at High-Yield Investing applies this tactic on a grand scale.
But unlike broad market funds, this closed-end fund specifically targets small to mid-sized tech stocks – the sweet spot right now. The fund has already racked up a 35% gain this year, outperforming 99% of its category peers. And it’s just getting started.
If you’d like to get the name and ticker symbol of this pick (and access to our complete portfolio), go here to learn more now.