Earn triple dividends with low risk. Sounds too good to be true. Current market conditions are perfect for doing exactly that. World economies are in turmoil. Everyone is worried that whatever cash they have in the pocket could be worth quite a bit less overnight. While there are no sure things, somethings are pretty safe and certainly better than putting your wealth under your mattress.
Note: this article assumes the reader is somewhat familiar with basic stock and stock option terminology. There are a few critical definitions at the end but they aren’t all inclusive. Refer to other sources for more detail.
No matter what happens to the dollar, yen or gold bullion, certain large multinational conglomerates will survive and collect their bills in whatever form is still viable because people and other companies need their “stuff”. One example is DOW Chemical. On any day the average person in all developed and developing countries everywhere in the world comes in contact directly or indirectly with a DOW product every hour. Whether we’re paying in dollars, gold or grains of rice, we’re going to be putting profits in DOW’s pocket as long as we’re not living in caves or tents in the desert.
Currently companies like DOW are selling at P/Es of 7 – 15 and paying dividends of 3% – 8%. Barring a total dislocation in the world economic system, DOW will sell for it’s current price or higher within the next 5 years and will pay a dividend in the interim.
There is a universe of stocks like DOW that I term “safe stocks”. If you are patient you won’t lose money. This doesn’t sound all that exciting unless you can collect multiple times the dividend while waiting for the world economies to stabilize.
A safe stock is one that you, as a rational investor, believe will retain value over your time horizon, whatever that is. With the triple dividend strategy you don’t need to make money on stock appreciation to have an attractive return. Chinese Internet stocks, Greek banks and gold SPRs are not “safe stocks”.
Do your research. Pick stocks with low P/Es, stable dividends, solid international revenue sources. The stocks MUST have a LIQUID options market. Additional pluses are if the stock is near historic lows and moves in a moderately narrow trading range.
Now that you have picked your target stock(s). Do not buy it! That’s right, don’t buy it. Sell a slightly in the money put option and allow it to be exercised. You want to be “put” and take possession of the stock when the put option you sold is exercised. The perfect put option will have an expiration date before the next ex-dividend date and have an option premium greater than the quarterly dividend. The premium is the amount of the put price that is not in-the-money. If you do get “put” your net cost of acquiring the stock is the put option strike price minus the premium and you are on your way toward collecting the second dividend.
The entire strategy is that the put option premium expires (one times the dividend), you take possession of the stock, collect the regular dividend (your second dividend) then sell a call option with a premium equal to or greater than the regular dividend (your third dividend) that expires or is exercised after the stock goes ex-dividend.
Lets examine the possible outcomes.
The stock rises above the put option strike price you sold. If the put option you sold expires worthless, sell another put, pocket your profit and reload. Keep selling puts until you actually are “put” or until the stock price rises so far it no longer fits the “safe stock” criteria. If you can not find any more safe stocks you should not continue to use this strategy unless you want to become a speculator.
The stock ends the period at or near your original put exercise price. This is the perfect case. You’ve made the regular dividend plus two option premiums, that if you’ve sold your put and call options correctly, will be equal to or greater than the dividend, giving you a net profit of 3 times the dividend. If you have not had your call option exercised, sell it again until you get “called”.
If the stock declines significantly and you get “put” at a loss. Remember that you already collected a premium for the put option, will collect a regular dividend and can collect an additional premium for selling a call option. These three together provide a significant downside cushion in the event of a stock decline. If you correctly picked a “safe stock” your chances of a significant net loss is very low.
There are as many scenarios as there are trading days but if you keep sight of the three “dividends” and their effective dates you vastly reduce your chances of a net loss. If the stock declines, it would have to decline approximately 3 times the dividend before you suffer a net loss. If you are a little more comfortable with options, this strategy can be enhanced into a higher return, low risk strategy. All this ignores commissions but if you execute this strategy by having both the put and call options exercised, you will only pay two option sales commissions, which are usually less than stock commissions and 2 nominal exercise fees.
Definitions:
Call – an option to purchase a stock at a “strike” price until the “expiration” date
Put – an option to sell a stock at a “strike” price until the “expiration” date
Premium – the amount of the option price that is not in-the-money.
In-the-money – The amount of an option price that represents the current cash value of the option.
Premium – The amount of the option price that is the speculative value of the option related to time.
Note: The total option price = Premium + In the money
Ex-dividend date – The shareholder of record on this date receives the dividend regardless of whether they own the stock on the (later) date when the dividend is actually paid.
When a company pays a dividend, in theory the price of the stock goes down by the amount of the dividend on the “ex-dividend date” so if you are short a call you are getting a double dividend on the ex-dividend date.
The author does not have a position in DOW or plan one in the near future.