Retirement planners usually advise investors to hold a
combination ofstock market and fixed incomeinvestments in their
portfolio. Investments could include mutualfunds ,
, or individual securities. Ten-year Treasurynotes offer ayield of
1.85%, which means an investor using traditional planning tools
would earn about $185 on a $10,000note .
Because interest rates have fallen so low, many investors are
taking on more risk in pursuit of more income. This decision could
lead to devastating losses if market conditions change suddenly,
like they did in 2008. Rather than shifting assets to excessively
risky investments, income investors should consider a different way
to use traditional investments.
Fixed income investors can diversify withreal estate , which is
also an income producing investment. Investors can participate in
that sector by buying real estate investment trusts (REITs), but
picking the right REIT can be a challenge.
UnderIRS rules, REITs are required to pay out a high percentage
ofearnings as dividends. Since the earnings can be increased
bydepreciation and otheraccounting charges, the dividends can
consume a large amount of thecash flow , whichputs the REIT at risk
of being unable tofund its operations. Rather than trying to find
the best REIT, we can use the
Vanguard REITIndex ETF (
to track a REIT index that invests in companies owning office
buildings, hotels and other real property.
VNQ reports adividend yield of about 3.6% based on the payments
from the past 12 months and generally pays adividend quarterly. The
specific payment amount varies and tends to increase in the fourth
quarter. In the first threequarters last year, the dividend
averaged 51.5 cents. Assuming a similar payout over the next 12
months, we can conservatively estimate that the income from VNQwill
be about $2, or about 3%.
While 3% is a low yield, it is significantly higher than the
yield of long-termTreasuries . In addition to higher income, VNQ
also offers potentialcapital appreciation . Realistically, there is
very little potentialupside inbond prices after a 30-yearbull
With coveredcall option writing, we could increase the income
from VNQ. This strategy is not really any riskier than owning VNQ
outright. If VNQ falls, thecovered call writer and the stock owner
who doesn't use covered calls will experience a loss. But the
covered call writer's loss will be smaller. If VNQ goes up, both
investors will gain, although those gains are capped with a covered
call. The biggest difference is that covered calls could almost
double the annual income from 3% to 5.4%.
Rather than describe this idea in theoretical terms, let's dive
in and use real numbers. At the time of this writing, VNQ was
trading at $68.09 a share. You could buy 100shares of VNQ and sell
acall that expires in March with astrike price of $70 for 28 cents.
Eachoptions contract is for 100 shares of stock -- selling this
call generates $28 in income immediately. Over the next two months,
if VNQ announces a dividend, and they have paid a dividend in March
in the past, you'll receive the dividends just like you would if
you hadn't written a covered call.
When theoption expires, if VNQ is trading above $70 you will
have to sell the shares at $70. Assuming you sell the shares, the
total return would be about 3.2%, or 1.6% a month. Thisprofit comes
from the $28 options premium and the profit on the shares. If there
is a dividend payment of 51.5 cents, that return could rise to
If VNQ is below $70 at optionsexpiration , we see a return of
about 1.2% from the dividend and options premium and will be able
to sell more calls. Repeating this strategy throughout the year
could increase your annual income from VNQ to 5.4%, assuming we
find similar trades five more times a year ($0.28 x 6 = $1.68 + $2
dividend yield = $3.68/$68.09 x100 = 5.4%).
Markets are always changing and investors need to adapt. In a
low interest rate world, writing covered calls is one way to adapt
Action to Take -->
Buy VNQ at themarket price and sell one VNQ March 70 Call at the
market price for each 100 shares of VNQ purchased. Set stop-loss at
$64 on VNQ but do not use a stop-loss with the call. If VNQ falls,
the call will expire worthless and the income received will partly
offset the loss in VNQ. If VNQ closes below $70 when the options
expire, the income from the options premium and dividend would be
1.2% in two months. If VNQ closes above $70, the stock will
becalled away and your profit will be 4% in two months, including
This article originally appeared on ProfitableTrading.com:
Income Investors Could Almost Double Their Yield
With This Trade
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