Equity strategies to boost your dividend income

By Peter Moussa,

It’s a well-trodden path to seek an income stream by chasing dividend yield in a share portfolio. However, there are several options available to investors to enhance the yield they achieve.

The most common of these strategies is a buy-write strategy, which relates to selling a parcel of shares in the future at a pre-determined price and receiving a yield for entering the contract. This strategy is often done around earnings season and before a stock is about to go ex-dividend to capture three dividend payments over a 13-month period. This article explains the mechanics of the strategy as well as the pros and cons to consider.

Introducing the covered call

A covered call is where an investor physically holds shares and sells an option to sell those shares in the future at a pre-determined price. It is a common yield enhancement strategy used by investors to boost income from their stock portfolio.

For example, an investor buys a high yielding stock at $50.00 a share and is comfortable to commit to selling the stock at $55.00 in six months, even if it turns out the market price for the stock at that time is higher. To implement the strategy, the investor can take out a covered call at a strike price of $55.00 that matures in six months. The additional yield earned by the investor is the market price to purchase the covered call on an exchange like the ASX.

The investor selling the covered call retains any dividends and franking credits held over the holding period.

At maturity there are two possible outcomes, if the stock closes below $55.00, the investor has earned the income from the dividend and covered call and are not required to sell their shares.

Alternatively, if the stock closes at or above the chosen strike price, then they are required to sell the shares at $55.00 and accept a 10% increase over the original purchase price in addition to income earned from dividends and the covered call.

The risk in this strategy is that the investor must retain the physical shareholding over the term of the contract, so if the share price falls any unrealised losses may only be partially offset from the covered call and dividend income. The other risk to consider is that the share price rises dramatically above $55.00 as the investor has capped their upside given their precommitment to sell at that level.

The three dividend strategy

One-way investors can further enhance their income is by timing the purchase of their share approximately one month before the stock goes ex-dividend. This helps achieve two things, firstly a stock that pays a dividend every six months would declare a dividend soon after the purchase date, if timed correctly. In another six months a 2^nd dividend would be declared and six months later a 3^rd dividend. This captures three dividends in a 13-month period. Investors who wish to take this approach can choose to sell a 13-month call option to make sure that they are not forced to sell their stock before all three dividends are harvested.

The combination of the two strategies above is often combined with leverage tools such as margin lending or protected equity loans, as they help offset the borrowing costs while giving investors additional exposure to the strategy. The risk with any lending of course is that it can amplify both the potential gains and losses should the value of the stock portfolio decline.

To discover more call 1300 683 106 or email us on investordesk@nab.com.au

View all Investment Insights and Articles

The information contained in this article is believed to be reliable as at January 2024 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article.

Investments

Analysing equity market dips

Article

Buying market dips is a common method of seeking profits from recoveries or averaging down an entry price into stocks, but there are a number of things to consider.

The cost of missing share market rebounds

Article

In market downturns, investors may panic and sell down their share portfolios. The resulting damage to long term returns can be significant.