By Robert Hauver

Dow dividend stocks aren’t usually mentioned in the world of high dividend stocks, but selling cash secured put options is a way you can earn some impressive double-digit annualized yields out of even these modest dividend paying stocks.

We screened for the top 7 put selling yields for DOW dividend stocks and came up with these 7 option trades:

(All of the above put bid yields are based upon 100% cash reserve)

As you can see, these put yields far outstrip the dividend yields, and in a shorter 5-6 month time period.  Hence, the annualized yields are pretty impressive.

We’ve added some of these put options this week to our Cash Secured Puts Table, which will show more detail.

Why sell cash secured puts, instead of just buying the stock outright?

1. More Risk Protection – By earning the higher put option $, you’re lowering your break-even cost, and giving yourself greater downside protection.
2. Better Cash Flow –  You get paid the put premium within 3 days of selling puts, as opposed to waiting each quarter for a dividend payout.
3. Higher Yields – This happens 2 ways: In the above trades, the put yields are 2 to 9 times that of the dividend yields.  Also, with your lower breakeven cost, if the shares do get assigned/put to you, the ultimate dividend yield on the underlying shares will be higher, due to its lower cost.
4. Potential Tax Deferral –  The IRS rules state that,”If a put you write is exercised and you buy the underlying stock, decrease your basis in the stock by the amount you received for the put. Your holding period for the stock begins on the date you buy it, not on the date you wrote the put.” (Source:www.IRS.gov/publications)         This means that you don’t have to pay taxes on the put $ you received until you sell the assigned underlying shares. If you hold the underlying assigned shares for more than 1 year, you’ve also converted a short-term gain into a long-term gain.
5. Knowing your “trade range” before trading-  This strategy tells you your maximum gain and break-even cost, before you invest, as opposed to buying, and hoping for price appreciation.

Cons

1. Options gains are always taxed at short-term capital gains rates, which will be higher than qualified dividend tax rates.
2. Put options sellers are required to have 100% “cash reserve” by their brokers, i.e., your broker will set aside 100% of the value of the underlying shares against which you sell puts. 100% cash reserve is always required in an IRA account, but, investors with thorough options experience may qualify for Options Level 3 trading status, which lets the broker reduce the cash reserve to a lower 25-35% approx. range, thereby employing leverage.  A note of caution here: if you do employ this type of leverage, it’s very important to keep track of your potential exposure, and not get in over your head.
3. Cash secured put selling is a strategy that requires a bit more of a hands on approach, as opposed to the “buy and hold” strategy. However, this strategy shouldn’t be confused with day trading – Put sellers make their sale, collect the put $, and monitor the put’s value during the investment term, as opposed to jumping in and out of a trade every day.
4. Less rally participation – The maximum gain on selling cash secured puts is the amount of $ you receive when making the put sale, so, this profit could potentially be less than the eventual price appreciation of a stock.

Is it worth it?

Some investors would argue that, if you do nothing, and the stock’s price declines, you could also own the stock a lower cost.  That could be happen, but looking at the possible outcomes in the market, selling cash secured put options offers a greater chance for income:

Another issue to consider here is time value of money, and what you’ll earn on your money, while you wait for a stock to hit your price.

In addition, due to the timing factor in options, time favors an option seller over an option buyer, since the buyer must guess the stock’s ultimate price direction and price level, and must be correct before the option expires.  That’s often a very tall order, and it’s one of the reasons that 3 out of 4 options expire worthless – which is a distinct advantage for an option seller – time is on your side.

Disclosure: Author is short INTC puts.

Disclaimer: This article isn’t intended as investing or accounting advice.