Generate Double-Digit Yields on Growth Stocks While You Wait for a Pullback
In the long term, stock market returns are the result of earnings growth translated to gains in stock prices and dividend payments. Studies using decades of data show that dividends account for a large amount of market returns. Data from Professor Robert Shiller, author of Irrational Exuberance and other books about the stock market, show that dividends have provided more than half of the total return from stocks since 1871. From January 1871 through July 2013, the total return from the stock market has averaged 8.97% a year. Dividends delivered 4.72%, on average, and price gains accounted for 4.25%.
Data like this support the argument that dividends are important to investors. However, this argument overlooks the fact that some of the biggest winners in stock market history have been growth companies that do not pay dividends. After the rate of growth slows, these companies sometimes start paying dividends and attract the interest of value investors.
Cisco Systems (NASDAQ: CSCO) is a great example of a stock that transitioned from a growth stock to a value stock. CSCO offers an above-average yield of nearly 3% and has been paying a dividend for about two and a half years.
Over that time, the stock has provided investors with an average annual total return of 16.1%. That is an impressive performance but is actually only slightly better than the 13.4% average total return of the S&P 500 over that time.
Before paying a dividend, CSCO was a stock market leader for more than 20 years. Over a 21-year period from its first trade in March 1990 until it paid its first dividend in March 2011, CSCO provided investors with an average annual return of 28.8%, all from price gains. This was more than three times as large as the average 8.7% annual total return from the S&P 500 over that time.
While dividends are important, investors should not exclude growth stocks like CSCO from their portfolios. Selling puts is a strategy that would allow you to generate regular income payments from CSCO.
Put options provide the buyer with the right, but not the obligation, to sell 100 shares of a specific stock at a predetermined price (the strike price) before a predefined expiration date. Sellers of put options have an obligation to buy the stock if the put buyer exercises their option.
In the case of CSCO, for most of the 1990s the stock price could have seemed overvalued to investors. Usually investors would consider a stock risky after it gained several hundred percentage points, but CSCO saw only a few minor pullbacks. In this case, waiting for a steep pullback that never came meant missing out completely on ever more gains.
Selling puts can provide a way to generate current income while you wait to add a stock to your portfolio on a pullback.
Puts expiring in three months often trade for about 3%-5% of the price of the stock. When selling a put, the buyer pays for it in full and the seller receives immediate income. If the stock continues higher, the put expires worthless and the seller can sell another put. If the stock is below the option’s strike price when the put expires, the seller will have to buy the stock at the strike price. In the case of CSCO, or other high-quality stocks, that would allow traders to profit when the stock recovers.
A margin deposit of about 20% of the strike price will be required to sell a put. This means the income is generated with only a small amount of capital, leading to high annualized rates of return.
For example, if you sell a put for 3% of the stock’s price four times a year, for a $100 stock that remains at $100 all year, the income would total $12. This would be a 60% return on the required $20 margin deposit.
By selling puts, you can benefit from growth stocks and earn income from stocks without dividends.
Note: If you’re interested in learning more about generating income through options, and finding out how my readers have made $6,000… $19,500… even $150,000 this year alone, then click here.