Yields on the 10-year treasury notes this week reached lows not seen since March of 2009. Yields on the 10-year UST went down to as low 2.59%, which is abysmal. Everyone is scrambling between markets looking for yields. Pension and insurance companies that have to hit target returns to cover their obligations are some of the bigger players being hurt by the lower interest rate environment. This is causing them to look to more risky securities such as equities for their returns, which is also where most individual investors are looking as well.
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When looking for relatively safe yields in equities, most investors look in the large cap sector and, more specifically, at companies that have steady cash flows and a good history of consistent dividends. The problem is that everyone is looking in the same area so the dividend yields tend to be suppressed.
Back to Basics
However, one overlooked but common strategy that can help to boost your yield in these large caps and allow you to own a relatively stable stock is the covered call write strategy. It's a basic strategy but it's one of the safest and most reliable ones average investors can implement. Let's take a look at some large caps that could be a candidate for this strategy:
|Company||Ticker||Market Cap||Dividend Yield|
|Procter & Gamble Co.||PG||175B||3.17%|
|General Electric Co.||GE||168B||3.06%|
|Johnson & Johnson||JNJ||163B||3.64%|
|Data as of August 18, 2010.|
As you can see, the yields on these large caps are relatively low, hovering around the 3% mark (with the exception of AT&T). Using a call-write strategy on these stocks can provide you with additional income, but at the expense of limiting your potential profits if the stock price goes up quickly.
A Call Write At Work
For example, if you were to use the strategy on Wal-Mart stock, you could buy the stock at its current price of $50.84 and sell a call option on WMT at a strike of $52.50 (with a September 10 expiry). You would receive the premium from selling the option of $0.37 per share ($37 per 100 share lot) in addition to the dividend from owning the stock, a good source of supplemental income. Now, if the stock price rises to above $52.50, you would have to sell your shares at $52.50, but that would still mean a 5% gain on the stock alone.
Sometimes it's tough to choose the right time to sell a stock, and this could be a great way to do it semi-automatically. One word of caution is that if the stock goes down you could end up losing, but if you are taking a long-term view, and are capable of holding onto these stocks for the long run, then this strategy may be suitable for you. Also, be sure to take into account transaction costs before writing covered calls. (For more on covered calls, take a look at Using LEAPS In A Covered Call Write.)
The Bottom Line
With yields where they are right now, investors will have to do some extra work if they want to achieve their desired yields. One good place to start is the call write strategy for large cap stocks. (If you are not familiar with options, take a look at our Options Basics Tutorial before implementing this strategy.)
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