When looking at the Dow Jones Industrial Index for income stocks, Dow Inc. (DOW) is right near the top for yield. But what if you could double the yield on Dow stock with an option strategy?
Dow Inc. Is Already A High-Yield Stock
Keep in mind, when a stock drops, the dividend yield rises (assuming the payout remains the same). While we typically aren’t thrilled with a stock getting cheaper, the dividend does offer some protection.
Specifically, Dow stock is 18% off its high, below its 200-day line and the market went to uptrend under pressure last week. Yield-based strategies might find Dow stock rising on their list of prospects.
Options traders can further enhance the yield on Dow stock by using a covered-call strategy.
Covered-Call Strategy On Dow Stock
When selling a covered call, the investor receives a premium and must sell the shares at the strike price if called upon to do so.
One call option contract represents 100 shares, so investors can sell multiple call options if they have a particularly large stock holding.
Over time, covered calls can increase returns while also decreasing the volatility of a portfolio.
The annual dividend on Dow stock currently pays around $2.80. The December 60 call option on Dow stock was trading yesterday around $3.10, generating $310 in premium in five months. In effect, the covered call increases the yield substantially.
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Increased Yield Offers Downside Protection
The combined income from the dividend and call premium offsets some risk should the stock continue lower. The $3.10 in premium received also gives a small buffer on the downside. That means if Dow stock trade 5.4% lower between now and Dec. 17, the covered-call trade still breaks even.
The total capital at risk in the trade would be $5,469, and if Dow stock went to zero, that’s the maximum loss for the trade. But that’s still better than buying the stock outright where the risk is higher without any offsetting income.
Covered calls are a fantastic way to generate extra income from a stock holding while also providing some downside protection.
But remember, you are giving something up in return. What happens if Dow stock skyrockets? Your shares are called away and you miss out on profits. There is an opportunity cost.
Investors would also need to weigh the pros and cons of the stock before initiating a bullish trade like a covered call.
On the con side, Dow stock has a dreadful looking chart with the price below the 21-, 50-, and 200-day moving averages.
The stock is poorly rated with a Composite Rating of 50, an EPS Rating of 55, and an RS Rating of 47. That might warrant waiting for a better entry point.
Remember options are risky. Investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions. Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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