One of the casualties of the Covid-19 crisis has been the mass culling of dividends from many of the biggest companies in the UK. As the economy shut down, almost half of the top one hundred companies in the UK cut, deferred, or cancelled their payments.
Now you may think this only affects hedge funds, fat cats and ‘the rich’, but I’m afraid you’d be very wrong. Many regular Joes and pensioners rely on these payments to live on and so this has been a devastating blow.
So, if I could tell you about a simple strategy to re-instate dividend-like payments on your stocks, I presume you’d be interested.
Well, I can. It is known as selling covered calls.
Let’s look at an example I spotted this afternoon using one of the UK’s former biggest dividend payers — Shell.
Shell have been one of the stalwarts of any income investors portfolio for many years, so when they cut their dividend by two thirds in April, it came as a huge shock. In fact, it was the first drop in the payment since World War 2. Ouch.
The quarterly payment is now forecast to be around just 13p per share.
So, if you own Shell shares — directly or in a fund — then the income gusher you were expecting, has been largely capped off. But, with a single straightforward transaction, you could bring in multiple substantial dividend-like payments whenever you wanted.
First up, let’s have a quick look at the chart.
Shell’s share price has been tracking sideways for the last few months and the stock is currently changing hands for £12.52 a share.
A quick check on my online brokers platform tells me that I could sell an October covered call with a strike price of 1,300p for 55p per share.
What does that actually mean?
Well, for every 1,000 shares that I own, I can sell a covered call that will instantly plonk £550 into my account. By comparison, the forecast Shell dividend for the equivalent amount of time will come in at a paltry £130.
It doesn’t seem so bad to lose that dividend now does it?
Now, of course you don’t get that payment for nothing. In return, you are promising to sell your shares for £13.00 each if they are trading above that level in three months’ time. That’s 48p more per share than they are currently trading at.
So, if you bought the shares at their current price of £12.52 each and they are trading above £13 on the 16th October, you would be obligated to sell them for a profit of £480. And remember, you still keep the £550 you were paid for selling the covered call and, chances are, you will still pick up the regular forecast dividend of £130.
Okay, that’s pretty good, what’s the catch?
Well, if the shares suddenly shoot way up, then your profit on the stock is capped at the strike price of £13. You will miss out on any profit above that level.
You are giving up some of the potential profit in return for a definite upfront payment and a fixed portion of the potential profit.
In my book, that’s a pretty good trade-off.
But, what happens if the shares stay at their current level or fall in price by October?
Well in that case, you get to keep the £550 premium from the covered call, the likely £130 dividend, and you will still own the shares so you can just turn around and sell another call to bring in another big slug of premium.
My clients and I make investments like this every day and I think it’s safe to say that once they learn how to generate their own ‘instant dividends’ using covered calls, they never go back to ‘buy and hope’ investing.