Six Times Better than a Bond

Asking me which one of the Investing Daily services I like the most is like asking a parent which one of their children is their favorite. Of course, the polite answer to both questions is “all of them,” but in truth that isn’t always the case.

At the moment, I am having the most fun with Income Millionaire. That’s a service I manage that is designed to generate a high level of cash flow from dividends and option premiums.

Normally, those types of trades are consistently profitable, but not very exciting. Its portfolio of nearly two dozen holdings pays an average dividend yield of 7.4%. That’s more than twice the yield of the 30-year Treasury bond, which is currently paying a little under 3%.

I could goose that number a little if I wanted to by adding some higher yielding holdings. For example, my Maximum Income portfolio for Personal Finance has an average yield of 9% thanks to its concentration in high paying “pass-thru” securities.

An extra percent or two of income would be nice, but I can do a lot better than that. By writing a combination of short put and covered call options against this portfolio, I can more than DOUBLE its annual cash flow!

Even better, I can generate annualized cash flow of nearly 10% on a holding that does not appreciate at all. Five months ago, we sold a put option on Spectra Energy Partners (NYSE: SEP) with a “strike price” of $35. We received $50 in option premium that represented 100 shares of SEP.

At the time, Spectra was trading around $40, so it appeared unlikely that we would have to buy those shares by the time this option expired in June. However, the market had other plans for us and SEP quickly dropped below $35. We ended up having to buy it at that price.

Fortunately, a few weeks later Spectra ran back above $35, at which time we sold a covered call option against it with the same $35 strike price. This time, we received $150 for those same 100 shares of SEP for an option that expires in September.

Watch your money grow…

If you’re doing that math, thus far we have received $200 in option premium spanning seven months. On an annualized basis, that works out to a 9.7% return on capital. By the way, that does not include the 8.5% annual dividend yield paid by Spectra.

On an annualized basis, the combined cash flow from this holding is more than 18%. We probably won’t realize any capital appreciation at all on this trade since both options have the same strike price. But I will happily accept an 18% annualized cash flow yield in exchange for no gain in share price.

If you think about it, that is essentially what a bond is. When you buy a bond, you effectively surrender the opportunity for capital appreciation in exchange for a fixed rate of interest over a specified period of time.

As I mentioned earlier, the U.S. Treasury would be happy to pay you 3% annually if you are willing to give up any chance for appreciation on your hard earned money over the next thirty years.

Does that sound like a good deal? It is if you are the borrower, but not so great if it is your money locked away for the next thirty years at a very low interest rate.

And that’s why I am having so much fun with options these days. Not only can I generate annualized cash flow more than six times what the government is paying, but I don’t have to bury my money for the next thirty years to do it!

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