How I Might Get a 55% Dividend Yield On WFC

I wrote previously about using deep in the money covered calls to boost your dividend yield. Basically, when you do a buy write and use the lowest strike price possible, you end up purchasing shares of a stock for a fraction of their trading price. If those shares pay dividends, your yield is substantially higher than if you buy the shares without writing the call.

Commissions included (also accounting for the commission I'll incur when my Wells Fargo Shares will be called) I paid $2.70 a share for WFC. I bought shares of the stock near the close yesterday (11/4/08) for $34.93 while at the same time selling the Jan '10 LEAP at the 2.5 strike (WWR AK) for $32.98.

If my stock isn't called until the expiry date, and Wells Fargo continues paying quarterly dividends of $0.34 a share, I will receive a total of $1.70 a share in dividends. Since I'll get $2.50 when the stock is called, my net dividend gain will be $1.50. That's a yield over 55%, given my net debit is $2.70.

I wrote previously that such an enterprise is worthwhile only if your net debit is less than the strike price, so that if/when your shares are called, you don't lose any money. For example, if you buy for a net debit of $2.70 and the strike price is 2.5, you'll lose $0.20 a share if the stock is called. That's correct, but I'd like to offer an addendum. If you do the transaction as near as possible to the close of trading on the day before the ex-date, you minimize lessen but by no means eliminate the chances of being called that day. If you're called on the ex-date or after, you'll get the dividend, which just has to be greater than the difference between your net debit and the strike price to make the transaction worthwhile.

I couldn't get WFC for less than the strike, so I acted in the last minutes of trading yesterday. Today is ex-dividend day. If my shares are called, I'll get the dividend. As it's $0.34 a share, starting today I can't lose money if the shares are called. I can still lose money overall, but that's only if WFC stops paying dividends and its share price goes below $2.50.

[Update 12/31/08: I received my dividend in early December. I have a $0.14 a share gain, factoring in all past and maximum future expenses. I cannot lose money on this trade unless WFC stock goes below $2.5 per share.

In trying this strategy again, and corresponding with another person attempting to implement it, I discovered that these deep in the money calls are exercised in great frequency. (1) I was aware of the fact that calls are more likely to be exercised right before ex-dividend day, but didn't think that this was very likely with LEAPs at low strikes. Turns out that it is. (2) According to the CBOE, options holders have until 4:30 P.M. Central Time to exercise their rights. Even making the above mentioned trade at 3:59 P.M. Eastern Time does not eliminate one's assignment risk that day, as the option buyer potentially has another hour and a half to exercise the options. I guess I was lucky with WFC not being called away soon after I placed the trade.

I still can't figure out how the person on the other side of this trade is making money when he exercises his call, unless he's betting on the underlying stock's direction the next day. If he does it before ex-dividend day, he pays me the strike price * contracts * 100. In exchange, he receives the shares, which are then valued at market price, and he gets the dividend. So, basically, he's getting the dividend, say $0.30 a share in exchange for paying me the strike, say $2.50 a share. Net result here is that he's paying $2.20 in addition to what he already paid for the calls to get the shares. Whether he gains or loses depends on how the stock trades after he gets the shares. My question is, why bother with buying calls and then exercising them shortly thereafter on the same day? Why not just buy the shares? Why pay the extra commissions to wind up in the same place?

The person I've been corresponding with theorizes that these are not ordinary traders on the other side, but those that are part of the market machinery. I can see that, but we still wonder, is it really worth it for them to do that? How much money can they possibly make?

Update 1/3/09:

Here's a potential answer. (Note that the link is a Word file. It doesn't appear to have viruses, but be careful.)]

So why did I choose WFC? It has a 2.5 LEAP call strike and a dividend that appears safe for the moment. It'll be worthwhile even if the dividend is cut in half. Best case scenario, WFC continues paying dividends and I'm able to roll my calls for credits or small net debits. Then I can make around 50% a year on it indefinitely. This is unlikely. Second best scenario, I get called at the options expiration date. Worst case, WFC goes out of business and I lose my small net debit. This is not that likely. Second worst case, my shares are called before the next ex-dividend date, and I end up making around 5% for my trouble (0.14/2.70). Overall, I think it's a pretty good deal.

Update 2/22/09: I had all my shares called on February 4, 2009. I suspect that the owners of the calls exercised them on the 3rd. If that's the case, I've made 5% on my investment over four months. Not too shabby, but I hope I receive the next dividend payment.

More information is always better than less. Click here for analysis on any stock, commodity, currency, or ETF.

For Those Interested in Ethical Investing

When I put the Ethical Investing blog carnival out of its misery, I said I would replace it with regularly scheduled posts on the topic of ethical investing. I also asked for others to send me links to their posts or websites on the subject. I have not kept my word.

Ron Robins, of Investing for the Soul, has gently reminded me about his site, twice. I'm sorry it took two times for me to post something.

Investing for the Soul is a great resource for those looking for ethical investing information. This includes information on green investing, corporate transparency and social responsibility, how religion interacts with investing, mutual funds, and many other topics. The site also has a list of suggested books and offers fee based services, such as helping you find investments that comport with your values, investment research, and portfolio auditing. Workshops and seminars are available as well.

If ethical investing interests you, pay Investing for the Soul a visit.


ESLR Update Trading Update

During the last few weeks my Evergreen Solar (ESLR) stock has been down in the dumps. I bought some more shares for $3.05 and sold a March 2.5 call for $1.22. My thinking was that the stock would probably stay a little above $2.50 a share, and I'd make $0.67 a share on that transaction when those shares were called in March (this can still happen). Ignoring all my short calls, my cost basis for ESLR is now $5.18 a share. (All my trades are listed on the right sidebar, near the bottom.) If all the calls expire worthless, my costbasis will be $3.75 a share. That is, the most I can lose on the stock is $3.75. Amazing that I originally bought it over $10 a share. The most I can gain if I don't buy back the calls and the stock is called away is $4.28 a share.

After I bought it at $3.05 near the end of October, ESLR promptly fell lower than $2.50 a share. Oh well, I thought, my cost basis for the last purchase, with the call was $1.83. But instead of buying back all my calls (the Jan '10 7.5s, and the recent Mar '09 2.5) for much cheaper than I sold them, I ended up doing nothing. I wanted to buy them, but they didn't go as low as I wanted them to. I missed buying back the Jan '10 calls by $0.05. I'd have sold them again today, as ESLR is now (11/4/08) trading at over $5.50 a share.

I don't expect it to rally forever, and think that I'll have another opportunity to buy my calls back at a profit and then sell them again. As the stock has soared over 100% since the end of October, I'm looking to buy puts.

Solar stocks are up pretty much across the board, so I don't think there's anything specific to ESLR itself causing its recent rally. ESLR had a crappy earnings report in mid October, then sued Lehman and Barclays towards the end of that month regarding the borrowed shares. There was also a UBS downgrade.

I'm still bullish on the company long term. It just has to survive this recession.

My previous posts on ESLR can be found here.

Election Day Will Finally Be Over and We'll Get On With Our Lives

I've voted in every election I've been eligible for since I turned 18. This will be the first year I'm not voting. I think I've finally realized how absurd it is. Put on a fake smile, kiss a bunch of babies, tell everyone you won't raise their taxes, promise a whole bunch of stuff you have no intention of attempting to do (even if it were feasible), sling some mud at the other guy, and say you're the candidate of change and reform. Each and every one of them are always candidates of change and reform, yet they all end up the same.

The Democrats are likely to take control of the two elected branches of government (I was going to say political branches, then reconsidered). They will be just as terrible as the Republicans were when they had full control. Why? Because laws will be passed. That is never for the better. That government is best which governs least.* Since we'll never elect people who actually believe this, for the last few elections I've been casting empty ballots--a kind of "none of the above" vote. Now I have better things to do than go to the polls, especially since this year it looks like there will be a big turnout.

The above might offend some people. For that I apologize. I actually have more particular things to say about each candidate, but rather than truly offend you I will forgo that exercise.

I never really found George Carlin funny, but agreed with what he said about some things. Voting was one of them. Whether he meant it or not, I agree with the following (caution, there's offensive language and gestures in the video that may not be suitable for everyone), and don't really consider it a comedy routine:

As this is a money blog, I shall refrain from talking directly about politics until the next presidential election. May the candidates you like the best (or the ones you think are the lesser evils) prevail.

I leave you with an excellent op-ed from Minyanville.

*This is often attributed to Jefferson or Paine, but there is no evidence they ever wrote or said it, as far as I know. It appears in the writings of Thoreau (one of my heroes, the slacker who mooched off Emerson) as just a general motto.


Buy and Hold Forever Dividend Stock Portfolio

This year's market turbulence has many investors calling the buy and hold strategy dead. Let's prove them wrong. My musings (here and here) on holding dividend paying stocks forever have inspired me to make a new, all dividend paying stock model portfolio.

It's composed of 43 stocks and one ETF, and is based on minimal research (more research is always better, but the goal here is to show how it doesn't take an investing maven to succeed with a relatively diversified dividend stock portfolio). Almost all the stocks were selected because they're household names that pay dividends. The other criterion was to take a couple of companies from every industry that came to mind, so that they wouldn't be clustered in one area, as most dividend ETFs are. As far as energy pipeline companies go, I took the two that I've been hearing the most about. As REITs are not really household names, the portfolio will have a REIT ETF instead of separate stocks.

Here's a list of companies by type (note that some companies may be classified in a number of ways that aren't shown here, and I might be leaving out a few--they're all in the spreadsheet though):

Boeing (BA)
United Technologies (UTX)

Anheuser Busch (BUD)
Diageo (DEO)

Banks/Credit Cards
American Express (AXP)
General Electric (GE)
US Bancorp (USB)
Wells Fargo (WFC)

Coca Cola (KO)
Pepsi (PEP)

Du Pont (DD)
Dow Chemical (DOW)

AT&T (T)
Verizon (VZ)

3M (MMM)
General Electric (GE)
Siemens (SI)

Campbell Soup (CPB)
Kraft (KFT)
McDonald's (MCD)
Yum! Brands (YUM)

Johnson & Johnson (JNJ)
Pfizer (PFE)
Sanofi-Aventis (SNY)

Household Goods
Church & Dwight (CHD)
Johnson & Johnson (JNJ)
Procter & Gamble (PG)

China Life Insurance (LFC)

Chevron (CVX)
Exxon Mobile (XOM)

Pipelines/Energy Transport
Enbridge (ENB)
Frontline (FRO)
Oneok Partners (OKS)
Overseas Shipholding (OSG)

Burlington Northern (BNI)
Union Pacific (UNP)

Real Estate
Vanguard REIT Index (VNQ)

3M (MMM)
Target (TGT)
Walmart (WMT)

Intel (INTC)
Microsoft (MSFT)

Altria (MO)
Philip Morris International (PM)

Con Ed (ED)
Duke Energy (DUK)

The portfolio will work as follows. Three hundred fifty dollars worth of each stock was purchased at the close on Friday 10/31/08. Fractional shares were purchased, as can be done with discount brokers like SogoTrade (for $3.00 a trade), with the commission of $3.50 a trade. So, this portfolio starts out with around $15,400 worth of stock, and a loss of $154 for the 44 trades.

As this is a buy and hold forever portfolio, no position will be sold, even if it stops paying dividends. If there is a spinoff (e.g., Target spins off a REIT or Procter & Gamble gives some shares of Smuckers as a dividend) any new stock will be added to the portfolio's holdings and the cost basis of the original stock will be reduced by the amount of the dividend (for example, when Altria spun off Philip Morris International, the spin off was worth $51.06 a share. Had this portfolio existed then, Philip Morris International would be added, and the cost basis of Altria would be reduced by $51.06 a share). If one of the stocks is bought out for cash (e.g., BUD), that cash will count as a dividend (even though it's a capital gain). That's the only way a stock can be sold in this portfolio. If a company in the portfolio is bought with stock, or if there is a merger, the new entity will replace the old in the portfolio. The idea is, buy the stocks and leave them alone. Just get the dividend checks.

Although I think all the stocks in the portfolio are good for the long haul (or else I wouldn't pick them), no doubt some of them (hopefully only a few) will go out of business, decrease, or suspend their dividends in the next few decades (a decrease at GE and probably PFE will come soon, but I think both companies will do well over the long term). Others, I'm sure, will do very well. Although I believe reinvesting dividends regularly boosts returns (e.g., just have your broker buy you more shares for free when the dividend comes in), for sake of ease dividends here will be reinvested once a year--or when the portfolio accumulates $353.50, whichever is later. Dividends will be reinvested in the companies either with the lowest payout ratios or the lowest yields (depending on how lazy I am).

Since I'm taking the minimal research approach, such a simple rule would work better than trying to decide which stock to reinvest in by doing research. Lowest payout ratio seems to be the better approach, but it involves more mouse clicks. Lower yields are easier to find out, but reinvesting in these stocks might make me buy them when they're too expensive. Higher dividend yields mean lower investor confidence, so it's best (not necessarily for capital gains purposes) to add new money to the stocks that are in the best shape. (This approach is the opposite of one I'd take with a diversified portfolio of index funds. It makes sense to add new money to the fund performing the worst, as this enables you to buy more shares when they're cheap and avoid buying shares of the funds that are doing better while they may be too expensive. As index funds are baskets of stocks and their composition changes over time, unless the financial system collapses these funds will not go to zero. Underperforming individual stocks can go to zero, however, so I'd like to avoid throwing new money at them.) Dividend reinvestment will not alter the cost basis.

Total return (capital gains + dividends) is always important. But because nothing will be sold in this portfolio, what I'm calling "Dividend Return" (dividends received divided by total invested and expressed as a percentage) will be the better measure. The portfolio will start out with a negative 1% return (that's the $154 spent on commissions).

The portfolio will be tracked in the spreadsheet below (also available for easier viewing here). The dividends received will be updated at the end of every month (probably over the weekend) here. For sake of ease, the ex-dividend dates will be used rather than the dates dividends are paid. Should a dividend not be paid after an ex-date, it will be subtracted from the portfolio.

Since all things are relative, the portfolio will be measured for total and dividend returns against the S&P 500, represented by the ETF SPY. Since buying SPY involves only $3.50 in commissions, it starts out with only a negative 0.02% return. Its dividends will be reinvested annually. When I get around to it, I might add the total bond ETF BND as a measure. Note that if the portfolio or SPY do reasonably well (at least 8% annualized total return) compared to CD rates, buy and hold is not dead. If the portfolio and SPY grow less than rates offered on CDs, (the highest 5 year CD rate I could find is 5.25%--I'll track these as time goes by), then I'll concede that buy and hold is dead.

Of course, this will take a few years.

Disclaimer: The above is for educational and entertainment purposes only. Do your homework before investing.

Disclosure: At the time of writing, I owned JNJ, PG, and PM. Some may ask, if all the above stocks are so great and you believe in buy and hold, why don't you own all of them? The bulk of my investments are in a target allocation mutual fund to which I contribute regularly without looking at the statement (that's so I don't stop contributing). Individual stocks are for play.

Update 11/3/08: I made an error with the ticker for American Express. I had AXM (America Movil) instead of AXP for some reason (carelessness). This has now been corrected.