August 29, 2010 at 13:06 PM EDT
Defending Your Portfolio With Dividends (Members Only)
In uncertain markets, dividends can give you a critical investing edge . As you can see from the chart on the left, just mindlessly investing in dividend-paying stocks can give you more than a 2:1 annual advantage in your investments .  Of course, here at PSW , we teach the art of selling options premiums - something that turns virtually any stock into a " dividend " payer.  For example, MSFT is only a small, 2% dividend-payer but a fairly solid cash-machine of a stock that we don’t feel is likely to go bankrupt overnight so it makes for a nice safe staple in a long-term portfolio.  But MSFT is also a very poorly-run company that hasn’t grown in 20 years but we can make it a much more interesting stock by simply selling covered calls. For example, we buy MSFT for $24.23 and we sell the Sept $24 calls for .77.  This lowers our effective basis to $23.46 and selling the call puts us in no special danger - we are simply agreeing to sell MSFT for $24 on expiration day in September (the 17th).  Should the stock be called away from us, we make a .54 profit or 2.3% of our net $23.46 cash investment in less than 30 days.  That works out to a 26% annualized ROI and, even if we get called away, we can simply buy the stock again and again and sell calls every month.  Of course, you can optimize all this with timing and we favor stocks that are on sale - this is just a very simple example of how our most basic options strategy can drastically boost your annual returns on any stock in your portfolio. Let’s say you don’t want to mess around with MSFT every month.  You can simply sell the 2012 $22.50s for $4.40, that drops your net entry from $24.23 to $19.83 and getting called away at $22.50 would be a profit of 13.5% over 17 months PLUS you would be getting your .52 annual dividend so let’s call it .75 more for a total profit (if MSFT holds $22.50) of $3.42 or 17.25% - 1% a month certainly beats what the banks are offering these days!  Not as sexy as the 26% ROI you make by working the trade every month but you do get a built-in cushion that drops your break-even price to $19.83, which is a full 18% below the current price.  So MSFT would have to fall…
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