Writing Covered Calls on High Dividend Stocks

Why It's a Self-Defeating Option Strategy

Writing covered calls on high dividend stocks seems like a perfect marriage between two income oriented strategies. To receive a great dividend plus collecting additional covered call income - what could be better than that?

Unfortunately writing calls on high yielding equities is a self-defeating option strategy.

Drawbacks to Covered Calls and High Yield Stocks

There are a couple of notable drawbacks to this approach.

The first drawback is the nature of the large dividend itself. The rule of thumb is that when the amount of the dividend exceeds the "time value" that remains on the (at the money or in the money) option, you can be pretty sure that the holder of the call will exercise the option prior to the ex-dividend date.

Being assigned on a covered call isn't the worst thing in the world, of course. Presumably you're still going to be profitable on the position. But obviously you're not going to be maximizing your gains as you'd hoped.

But there's actually a second reason why covered call writing on high dividend payers fails to live up to its promise.

In the end, selling calls on high yielding stocks, like the equally misguided dividend capture strategy, is a shortcut that frequently disappoints.

I write about this more extensively elsewhere (please see the resource below), but the short version is that dividends have a very real impact on option pricing, and a dividend (more specifically, the ex-dividend date) acts as a serious headwind when it comes to the pricing of premium on a covered call.

Since the stock is anticipated to drop in price on the ex-div date by roughly the same amount of the dividend, that dividend actually serves as a drag on the call option pricing in expiration cycles that include an ex-dividend date).

In fact, there is another approach that combines option selling and using a company's dividend cycle to your advantage that I believe is much smarter, more effective, and produces higher returns (and which I rely on myself).

Dividend Absorption - The Smart Options-Based Alternative to Dividend Capture

Forget about building wealth by writing calls on high yield stocks and forget about dividend capture. These may sound like brilliant strategies, but in the real world, they just don't work very well.

In my opinion, you do yourself (and those who financially rely on you) a huge favor by considering an approach I call Dividend Absorption.

To learn more, click on the link above, or the graphic to the right.

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