Turning Non-Dividend Paying Stocks Into Income Machines


Selling covered call writing is one of the simplest yet the most powerful way of enhancing your long-term performance courtesy of breakeven reduction and high probability of profit. When you buy stock, there's a 50/50 shot that you are going to make money and if you miss out on the most lucrative days, you barely make any money in the end. By selling covered calls, you are willing to sell stock you already own at a price higher than current market value. What's at the heart of elevated probability of profit? Cost basis reduction as you received a cash premium which will help offset potential losses. This interesting as it reduces not only maximum losses but also your standard deviation. To put context around that metric, it's synonymous with risk. The lower your standard deviation - while creating enough occurrences and putting non-correlated trades on - the more predictable your returns is going to be. Makes a lot of sense, right? Receiving a fat cash premium can also be considered as a dividend.

Before we get into a real-life example, I'd like to bring up the following tremendous piece created by Michael Rechenthin, Ph.D. aka Dr. Data of TastyTrade. He conducted several Monte Carlo simulations based on historical data. If you sell ATM covered calls (so you buy stock at 50 dollars and you agree to sell it at 50 dollars in order to get the highest cash premium) you significantly outperform the S&P-500 in a downtrend, sideways market and uptrend on a risk-adjusted basis. In an uptrend, however, traditional buy and hold investing will exceed the returns of covered call writing but who knows what comes next? Furthermore, the outlier risk is subdued compared to traditional ETF investing. In a rangebound market you'll get the following picture (starting with a $100,000 account) for selling monthly ATM calls on the SPY tracker. So, it's not about getting the highest short-term profits, it's about posting more consistent returns and patience is the virtue you should definitely possess.

SBA Communications

SBA Communications is a fast-growing cell tower REIT that enjoys the secular growth trend in 5G along with long-term lease agreements providing durable and steadily growing cash flows. Yesterday, the company reported better-than-expected FFO and revenue numbers and is worth owning for common long-term investors. If you sell the 250 dollar covered call, you receive 6.2 dollars in cash premium (so $620 per one contract consisting of 100 shares SBAC) and there's a positive time elapse of 8.8 cents (8.8 dollars per contract) per day. But you also have upside potential from 242.51 to 250 dollars. By selling the covered call, your net exposure to the stock is now 61 delta, which means that if the price goes up by 1 dollar, your total position is going to rise by 61 cents and vice versa. By selling covered calls, you reduce your directional exposure to underlying and thus the impact of a changing share price. That's precisely what makes this strategy a no-brainer for conservative investors: less outlier risk (to both the downside and upside) making it easier for us to be non-emotionally bonded with our investment strategy.

Reducing your cost basis improves your win rate and provides your portfolio with more consistency. It's a particularly appealing way to digest drawdowns while staying in the game (you don't close out your stock position and enjoy the positive consequences of time elapse).

The more you go out-of-the-money, the less cash premium you receive but the higher your possible maximum return is going to be.

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