Boost Your Dividend Income With Covered Calls: The Step-By-Step Guide

The idea of dividend investing, and especially dividend growth investing, makes a lot of sense to me.  Naturally there are numerous strategies out there that will work well, but there’s just something about receiving that quarterly payout that gets the investment juices flowing.

Even beyond the historical outperformance of dividend paying companies and aside from the idea that the best companies tend to be the ones increasing their payouts each year; there’s an “X factor” related to the process.

There’s something tangible and rewarding about owning a company like The Coca-Cola Co (NYSE:KO) or PepsiCo, Inc. (NYSE:PEP) or Procter & Gamble Co (NYSE:PG).

If you’re ever feeling down about your blue-chip holdings, here’s an easy exercise to cheer you up: go into a Wal-Mart Stores, Inc. (NYSE:WMT) or other busy grocery store and find the shelves where your company’s products are located.

Store Aisle Dividends

Watch as people routinely chose to buy Coca-Cola or Bounty or Lay’s or Dasani instead of the generic product. I mean think about that last one. It’s just purified water. Yet over and over people are willing to pay a premium for the brand.

And you own a piece of that. Ticker symbols aren’t just an arrangement of letters sitting next to a blinking number. When you own shares in a company you have an honest claim on the underlying assets of the some of the largest and best companies in the world. If you owned enough shares you’d eventually control the business and could have Coca-Cola start selling “Joe’s Soda” or whatever you’d like.

Granted the vast majority of us will likely never get to that point (and you probably wouldn’t want to mess with “the real thing”) but it nonetheless underscores the point.

Better yet, the reward of ownership is proportional such that each share you own is just like a share that the founding family or CEO owns. The rewards, in this scenario, dividends and an underlying claim on future profits, flow to you consistently.

So nothing that I am about to say should take away from that…

The concept of owning pieces of excellent businesses that chose to pay you more each year is very much intact. However, I would like to offer some possibilities to supplement this process. There are a few alternatives out there, but for this article I’d like to highlight the idea of owning dividend paying companies and choosing to selectively sell covered calls as well.

This alternative addresses a very common scenario. Let’s imagine that you’re perfectly happy with your holdings, but you would like to derive a bit more income from your portfolio. The dividend cash flow that it provides is solid, but perhaps a bit shy of your goal or ambition.

You have some possibilities. For one you could elect to search for higher yielding securities. Of course you would want to continue to hold high quality businesses, so this endeavor may be limited.

Alternatively, you could choose to sell a portion of your holdings each year – say a percent or two – to add to the dividend income stream. This can work, but it also subjects you to the whims of outside market bids.

A third option (in this case literally) could be selling a covered call on one, a portion or all of your holdings.

So What Is A Covered Call?

Covered Calls
Source: Option Monster