How I'm Doing Stocks These Days
Preface and disclaimer: This blog entry is something I have never attempted before, treating a personal finance topic. I am not and never have been a financial adviser of any stripe, nor have I ever offered any financial advice to anyone in a professional capacity. This blog and any financially-related items I may write in the future are presented for discussion purposes only. If you follow the methods I document here, you do so entirely at your own risk. I have no information about you or your financial situation and therefor cannot advise you on financial matters in any way. Here be dragons. Past performance is no indicator of future results. Contents may have settled during shipping. Consult your doctor if you have an erection lasting longer than four hours. If not fully satisfied, un-read this blog and return it to the Internet.
When I last changed jobs, in the fall of 2021, I rolled over my previous job's 401(k) account into a self-directed IRA. How to invest that money was something I decided to figure out on my own. It has been an iterative process, but now I think I have arrived at an approach worth sharing. Maybe I have re-invented a (financial) wheel here, and the commenters will be swift to tell me so. But even if so, I Did That.
Throughout this blog entry, I have linked to Investopedia definitions for terms that could possibly be unfamiliar to people. Hopefully, nobody thinks the Irish Republican Army is one of the topics of this post.
The three legs of this approach are: stocks, dividends, and call options.
Select and Buy Stocks
I looked for stocks with a with dividend yield of at least 3.5%. The higher the better, but I did reject some with what seemed to me to be crazy double-digit yields because of other factors.
You want stocks with lower Beta, which means less of the swings that will drive you crazy and not-coincidentally play havoc with your options prices. Beta of less than 1.3 should be fine for this. Negative beta is OK too, as a hedge, if you think the broad market is going to take a dip.
Check that there is robust market activity on the stocks' options, particularly the calls within 10-20% of the current price and with about six months until expiration. These are the options in the sweet spot for this method.
Also check the last several ex-dividend dates for the stocks on your target list. I found it helpful to make a column of these expressed as weeks within each calendar quarter, so they looked like M1W3 for 1st month (Jan, Apr, Jul and Oct) Week 3, and M3W4 for 3rd month (Mar, Jun, Sep, Dec) Week 4, and so on. You need to own the stock on the ex-dividend date to get paid that quarter's dividend. You do NOT necessarily need to own it on the date the dividend is paid, which can be several weeks later. Once you have seen the last few historical ex-dividend dates, you can predict the next couple to within a few days. This will guide your choice of options expiration date.
You really want to buy the stock in even lots of 100 shares. Less than 100 shares and you're locked out of the options portion of the method, which is giving up a fair bit. So the share price needs to be affordable. If you're starting with a small amount of money you can go to share prices as low as $10, but much lower than that makes the options sales tricky, so I would probably be looking for other things to do if I were starting with less than $1,000.
Sell Covered Calls
You now need to make sure your brokerage account is approved for options trading, to include selling covered calls. In the firm I use, this means "Level 2" so I can sell options backed by stock I own. It did not require me to put up any margin, which would be beyond my comfort zone at this time.
Sell covered calls with strike prices at least 5% or as much as 15% over current share price, and with expiration dates about 6 mos out. The expiration date should fall after next two projected ex-dividend dates, so you're locked in for two payouts of quarterly dividend before the stock goes away (if it does - see below). Pick your strike prices carefully; it may be more of an art than a science.
Let It Ride
I found the next part really difficult, I hope you have the strength to do it well: Leave it alone for now. Set alerts for + or - 10% price moves, but if they don't fire, the time passing is what's making you money. Every day that goes by with the price of the stock relatively stable, the option you sold is losing value. Since you sold it at the higher price, this is a win for you.
If the stock goes down significantly, you can consider buying back the options you sold and selling new ones at a lower strike price. This will net you some additional cash to offset the loss in the underlying stock. You can also just patiently await recovery, which may be appropriate depending on why you think the stock declined.
Remember too, all this time, you're getting two quarterly dividend payments while the option's value dwindles. If the dividend payments are cut or skipped, that's a danger signal and you should consider buying back the option (probably will be way less than what you sold it for) and getting out of that particular stock.
Options Expire
Hold the stock until option expiration. Ideally the stock will be just a hair below the option strike price, and the option will expire worthless at the market close on that Friday. The following Monday you can do it all over again.
If the option's in the money (the stock is above the option's strike price) on expiration day you'll be selling the stock for the strike price, the cash will appear in your account, and Monday you start again with another stock (or the same one, if you like). Most of the time my attitude about stocks that get called away is, "so it goes."
If getting it called away bugs you, you can try this: On the Tuesday or Wednesday before expiration, buy back the option and then sell a six-months-later one. If the stock's up, you can sell the new one at a higher strike price. This will net you a higher price and some extra cash into your account when you do this trade. Doing this takes advantage of the fact that holders of call options will typically not exercise them until the last minute, because it would sacrifice the value they have due to the time remaining until expiration. The extra value in options always comes from the extra time.
Conclusion
This would be the part of the article where I tell you, "I did this and I beat the market by umpty-ump percent!" Well, I have to say, I have spent the last year just tweaking this method and have only recently settled on its current (final?) form. The results I see so far are encouraging but also not yet significant enough for me, due to the small sample of time. So I don't have specific results to report. I'm setting a reminder for Feb 1 of next year for an update.