Boundaries and Prevention Learned From Four Experiments
I am primarily invested in dividend growth ETFs and stocks. The goal is to have increasing income with minimal effort. If I want more income from one of the dividend growth stocks, I can trade covered call options on shares that I own. But I want to have a boundary in my trades. I want the boundary to be a price that is high enough with an expiration date that isn’t too far into the future.
A boundary reduces the income I can make on each covered call option sale, but it also increases the chance that my shares won’t be called away. I want to prevent, as often as possible, the buyer of my option from calling my shares away. That is because I still want to own the shares and receive the dividends.
In this post I want to show you how I learned to gain options income and reduce the likelihood of having my shares called away. There have been four experiments. Each one was slightly different. The goal was threefold: receive dividends, sell covered call options for income, and, if the shares are called away, make a profit on the sale.
Broadcom (AVGO) is Worth Owning
I usually don’t want to buy an investment if I don’t see long-term prospects for increasing income. That is why I will buy shares of a company like AVGO. AVGO has a dividend payout ratio of 44.9% and a 5-year dividend growth rate of 28.57%. Therefore, I don’t want to give up the powerhouse of dividend growth. If I could, however, be reasonably confident that I could keep my shares and continue to collect the quarterly dividend and sell covered call options for even more income. It is like getting two dividends for the price of one – and the second dividend can be weekly or monthly! Each quarter, each 100 shares of AVGO provide me with $460 in dividend income if I hold the shares on the Ex-Dividend date.
1. My First Experiment Worked But Failed
When I first started using AVGO for covered call trades, I did some experiments to see what worked and what did not work. I built up 100 shares from February to August 2021. Then I purchased another 100 shares in October 2021. Then I sold covered call options contracts on those shares. I did this six times until those shares were called away at a profit. In addition to the profit on the sale of the 200 shares, I booked $1,353 in income from the six covered call options trades. But I lost the dividend potential when the shares were called away. But I also made $3,379 in profit from the sale of the 200 shares. But notice that dividends were not received. So it was a partial failure.
2. Experiment Number Two – Better But Failed
In my second experiment, I repurchased 200 shares in two buys in November and December 2021. I then sold covered calls on those 200 shares. Because options trade weekly for AVGO, I was able to book profits of $6,420 on those shares before they were called away. But I also received $820 in dividends. Furthermore, when those 200 shares were called away in January and March 2022, I had capital gain profits of $4,945.
So, as you can see, there were three pieces of profits: dividends, covered call options premiums, and profit (capital gains) from the sale of my shares. This was a better experiment, but I still lost my shares in the end.
3. Experiment Number Three – Higher Contract Profit
When my shares were called away in March, the price of AVGO shares dropped the following Monday. So I bought 100 shares to replace the 100 that were called away. I sold a covered call on those shares, and they were called away. The profit from that set of transactions was only $149.69, but I made that profit in less than a week. Furthermore, because I set the contract price so low, the buyer of my contract paid me $839. So my quick profit on that third experiment was $989 in one week. This was fun, but I did not get an opportunity to receive dividends in March 2022.
4. Experiment Number Four and the Bear Market
What do you do when the bear market enters? In April, May, and June, the price of AVGO shares was dropping. Each time it dropped I bought another 100 shares. So I bought my April shares for $633 per share, my May shares for $580 per share, and the June shares for $550 per share. That makes my average cost for the 300 shares $585.87.
The June purchase was done using a cash covered put option sale. In that trade, the buyer of my put contract paid me $539 for the protection they wanted if the price of AVGO shares continued downward. I do not recommend this type of option for a beginner, but I will talk about this type of option trade in a future blog post.
This experiment has been interesting. During the balance of 2022 I earned $5,607 in options premiums. However, I was also able to roll some of the contracts in a way that added income each time the share prices dropped. In addition, I received $3,840 in dividends in June, September, and December.
This experiment has been the most successful of the four. Why? Because I still own my 300 shares. Therefore, I can also receive the dividends in March 2023, assuming AVGO continues to pay $4.60 per share.
Profits from Four Experiments
The main goal of dividend investing is dividends. My total dividend income for 2021-2022 was $5,200. The secondary goal is income from covered call options. In 2021 I made $3,884 in AVGO options income and in 2022 I made $10,336 for a total of $14,220 in profit. During that same time period, I also received capital gains of $8.473. Best of all, the total income from these trades is almost $28K and $19,000 of that was in 2022.
For you to have success, let me suggest the things you should have in your options strategy. 1) First of all, pick stocks you want to own that pay an increasing dividend. 2) Don’t be in a hurry to buy all of the shares at one time. It is better to add shares over time, especially in a bear market. 3) Set your contract prices high enough to avoid having them called away. 4) Avoid options contracts with expiration dates too far in the future. 5) Trade options on stocks that have weekly options, when possible. This makes it easy to get profits 3-4 times per month on the same shares. It is better to get three small profits than swing for the fences to get a home run profit.
In my next post I hope to share how I pick the expiration date, the contract price, and the amount of profit I want from a covered call contract. Perhaps you cannot afford to buy AVGO shares. Don’t worry. There are other stocks that trade weekly options. Some examples include AT&T (T), Ford (F), General Motors (GM), Pfizer (PFE), and Occidental Petroleum Corporation (OXY). Do any of these have rising dividends? Only one of the five is the one I would pick. Which one would you choose?
Links for Learning
What happens when your options expire? Here is a helpful view of this from Investopedia: LINK
Remember, options contracts, whether monthly or weekly, expire on a Friday. Monthly options expire on the third Friday of the month.
Scripture About Treasures and Trust
When you do anything in life, there is an expiration date. You will expire. I will too. Think about the long-term implications of your decisions, not just the short-term profits.
Come now, you who say, “Today or tomorrow we will go into such and such a town and spend a year there and trade and make a profit”—yet you do not know what tomorrow will bring. What is your life? For you are a mist that appears for a little time and then vanishes. Instead you ought to say, “If the Lord wills, we will live and do this or that.” James 4:13-15
All scripture passages are from the English Standard Version except as otherwise noted.
Great info as always, signed up for your blog today.
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Hello Wayne, It is a very interesting article. First of all, in the last paragraph, you asked for the covered call which one I would choose? My answer is PFE .. T may not have much premium to write a call against it ( since it’s dud over the long time!). My other thoughts are in two prongs:
Have you considered the ETF – JEPI? It is call /write ETF and pays a monthly dividend … appx. 10% 2. During this volatile market, instead of owning stocks ( or dividend ETFs), instead, How about parking cash in the Money Market Fund such as Schwab Value Advantage ( SWVXX) which pays 4.26%? … of course it fluctuates weekly basis but in the rising interest rate market it usually goes up.
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Yes, I have considered JEPI. I also own shares of QYLD and XYLD as a easy way to get yield from options trades done for me.
In hindsight I would have been better off with JEPI instead of QYLD and XYLD, but I am okay just to sit tight on my small holdings.
I would agree with you regarding PFE as my first choice. In fact, I do trade options on our PFE shares with great success.
Regarding SWVXX, I would rather buy short-term CD’s that pay better than 4%. That is what I have been doing with some of our cash. 🙂
Regards, Wayne (Thanks for responding!)