What if you could earn even more from your favorite dividend stocks—without selling a single share?
Combining options strategies with dividend investing is a smart strategy that investors can use to boost the total returns they receive from online trading. Joining these two forces is a phenomenal strategy for increasing the return on investment (enhancing yield), reducing the downside risks of each investment, and creating extra income through simple options techniques.
What will you learn in this guide? We will take a deep dive into two strong options strategies that work well with dividend stocks: covered calls and cash-secured puts. More specifically, we will talk about how you can use these two approaches with strategic timing to supercharge your total returns. Learn why these two investment vehicles pair well together, but discover some of the risks that come with this form of investment, too! We’ve outlined everything you’ll need to know to get started.
Understanding Total Return in Dividend Investing
“Total return” in dividend investing provides a clear and complete picture of an investment’s performance, which accounts for all price fluctuations and income sources. Specifically, it refers to the overall profit earned from an investment, and this includes the dividends received and any capital gains, the price appreciation.
Total Return Formula
A good, concise way to help you understand total return in dividend investing is the following formula: Price Appreciation + Dividends + Any Additional Income = Total Return
Most dividend investors focus only on yield and miss out on options income, due to the yield providing a quick and easy way to assess the current income potential of an investment.
However, looking only at yield can cause traders and investors to choose stocks that are less liquid or have a lower potential for price appreciation. Yield doesn’t fully capture the potential for total return, so investors should focus on using options in conjunction with investing in dividends.
Option Stacking
It’s important to note that options can “stack” on top of dividends. Traders usually like to sell covered calls on dividend-paying stocks, which let them collect their usual premiums along with getting the dividends.
Why Options and Dividend Stocks Work Well Together
The great thing about options and dividend stocks is that they work well together for investors who are looking to boost their total returns. Stable, low-volatility stocks are ideal for conservative options strategies, which can bring in small, consistent profits over the long-term. Meanwhile, dividend stocks typically have predictable price behavior, making premium collection strategies more effective.
Timing is key when it comes to ex-dividend dates, which is the record date (or the business day before the record date if it’s not a business day). Traders who buy stocks on the ex-dividend date or after won’t receive the next dividend payment—the seller instead would get the dividend. It’s important for traders to buy their stocks before the ex-dividend date to maximize both dividend and premium income.
Covered Calls for Dividend Stocks
A covered call is a strategy with options trading where the trader sells call options on a stock they already own (long stock position) while also selling call options on the same stock. With the covered call, the investor or trader can collect a premium from selling the call option, and this can work as a cushion against possible losses if the stock prices go down. When the stock price goes up significantly over the call option’s strike price, the trader might have to sell their shares at the strike price.
Step-by-Step Breakdown
- The first step is buying a dividend-paying stock. This means that the investor owns 100 shares of this stock. This is the long stock position that makes up one-half of the covered call strategy.
- The next step is to sell a call option on this stock above the current price (out of the money).
- Traders can collect a premium from this sale upfront and keep it so long as the stock prices stays below the strike price and the option remains unexercised by the buyer.
What You Earn with Covered Calls on Dividend Stocks
- Dividend—Sell call options on a stock you already own (a dividend-paying stock), and you can earn a dividend along with the premium that comes from selling the call option.
- Premium Income—The trader can also earn premium income from simply selling the call option. If the stock price remains below the strike price and the option expires unexercised, the trader gets to keep the premium they made from the sale, a great form of passive income.
- Potential Price Gains—The maximum profit potential of the covered call strategy is if the stock price is at or above the strike price of the call by the time of the expiration date. If not called away, the maximum profit potential is the sum of the call premium and the difference between the strike price and the stock price.
Strategy Tips
- Time Around Ex-Dividend Dates—Avoid selling options that expire close to the ex-dividend date when writing a covered call to mitigate the possible risks of early assignment. Writers might be forced to sell their shares at a lower price than desired if call option holders exercise their options early to capture the dividend.
- Choose Expiration Dates After Dividend Payout—If you’re selling covered calls on stocks that pay dividends, it’s best to choose expiration dates that come after the ex-dividend date. This gives the trader the time to benefit from potential upside and avoid the risk of early assignment.
Example
Using Verizon (VZ) or Coca-Cola (KO) to collect a $0.60 dividend plus a $0.50 premium from call options is a good way to illustrate how investors make money from combining options trading with these dividend-paying stocks. The investors would ultimately collect a total of $1.10 (the sum of the $0.60 dividend and the $0.50 premium from the call option). The premium is received upfront from selling the call options, and the dividend would be paid out on the underlying stock.
Cash-Secured Puts for Acquiring Dividend Stocks at a Discount
A cash-secured put refers to an options trading technique where investors sell a put option and also set aside enough cash to cover the possible purchase of the underlying stock if the option is exercised by the buyer. The seller of the cash-secured put gets to collect a premium from the sale. Plus, they can acquire the stock at a lower price than the current market price, if the stock price falls below the strike price of the put.
How It Works
Using the cash-secured put is a terrific way to get into a dividend stock cheaper while getting paid to wait. We’ve outlined how this strategy ultimately works step-by-step.
- Set aside cash to buy 100 shares. This is to cover buying the underlying stock if the option contract gets exercised.
- Sell a put option below the current price. The trader gets a premium upfront for this sale.
- If assigned, you get the stock at a discount. Investors can pick up stocks or assets at a lower price than the current market price.
- If not, you keep the premium—boosting your “yield.”
Example
Sell a $95 put on Johnson & Johnson (JNJ) while it’s trading at $100 — collect a $2 premium and potentially buy at $93 net cost. The trader gets the $2 premium upfront just for completing the sales, and they can keep it when all is said and done, so long as the option isn’t exercised by the buyer. If the options writer of the put gets assigned, they can use the money they save to pay for the stock and get it as a discount, well below the current market price.
Strategy Combinations to Maximize Yield
Keep these strategy combinations in mind to maximize your overall yield when combining option trading strategies with dividend stock investments:
- Rotating Between Puts to Acquire Shares: Traders will sell put options at different strike prices and aim for a price at which they’d like to buy the stock. When the stock price falls below the strike price, there’s a good chance that the trader will be assigned, and they can buy the stock at that strike price. Traders can then acquire more shares by selling the new put at a lower strike price and then repeating the process over and over again.
- Rotating Between Calls to Generate Income: A strategy where traders can sell call options on an asset they already own, where they get a premium for the sale, and then close the position by buying back the option before it expires. Traders could also sell another call with a later expiration date, the process being repeated over and over again to generate recurring income from the premiums.
In both of these scenarios, options traders who are investing in dividend-paying stocks are able to use these repeatable monthly strategies that focus on bringing in income from premiums and dividends over time. It’s also important to note the various benefits that come from tax-efficient compounding—this can be done by putting investments in tax-advantaged accounts like tax-free accounts or Roth IRAs.
Check out a few of our favorite options trading platforms and trading tools for finding good option opportunities where you can work in dividend stocks to increase your overall yield by visiting OptionsTrading.org.
Risks and Considerations
Trading options on stocks and other underlying securities that pay dividends comes with plenty of its own unique risks—there are several considerations that new investors need to keep in mind before trading options around these stocks. We’ve outlined them here for your convenience, so you can gauge if this form of investing works for your goals and trading style.
- Assignment Risk—When you’re selling options, there’s always the risk of being assigned if the trade moves against you. It’s worth noting, though, that these risks go up even higher if the underlying security you’re trading involves a dividend. Calls may be exercised by the buyer, resulting in the seller losing the premium they got for initiating the sale.
- Missed Upside—Dividend payments affect stock prices, which trickle down into affecting options prices. Stocks that go ex-dividend have their prices drop by the dividend amount, which can make the call option price less attractive to buyers. On the other hand, it can make put option prices more attractive to buyers, resulting in missed upside.
- Timing Around Ex-Dividend Dates Can Be Tricky—The potential for short-term price adjustments and keeping track of different dates related to payouts can make timing trades around ex-dividend dates a bit complicated. If you buy stocks on or after the ex-dividend date, you aren’t eligible to receive the upcoming dividend.
Wrapping Up: Options + Dividends = Smarter Returns
Combining options strategies with dividend stocks can significantly enhance your total returns. Use covered calls to earn premium income on stocks you already own (and still collect dividends). Use cash-secured puts to get paid while waiting to buy your favorite dividend stocks at a discount.
The Benefits of Combining Options and Dividend-Paying Stocks
- Extra Monthly Income—Investors can generate additional income each month through premiums they get on the sales they initiate, plus any dividends that come from the stocks or underlying assets that are a part of the trade.
- Improved Cost Basis—When you’re reinvesting dividends and capital gains, you’re buying more shares of an investment, which means you’ll improve your overall cost basis.
- Lower Risk Compared to Aggressive Trading—Covered calls and cash-secured puts are good trades for generating predictable, steady income through premiums and dividends, which makes them much less risky than aggressive trading patterns.
- Works Well with High-Quality, Low-Volatility Stocks—Not only does option trading paired with dividend stocks work well with low-volatility stocks that produce predictable, steady returns, but these trades also work well with high-quality investments.
These are beginner-friendly strategies that don’t require daily trading or risky bets. Start with just one stock you already own or want to buy. Use a tool like our Options Profit Calculation or Explore Our Strategy Guides to test it out. Don’t leave income on the table—start boosting your returns today.
