Pay Yourself First With This Clever Income Strategy

If you’re like me, your main goal is to keep the income rolling in with a solid set of yield plays — but that doesn’t mean getting complacent once you’ve got your dividend portfolio in place.

Rather than ignoring the short-term swings in the broad market, a smart investor pays attention and looks for opportunities to boost his income stream, which sometimes means thinking outside the box. In addition to your typical buy-and-hold positions, I recommend you always stay on the lookout for new strategies that can complement the dividend payers you may already own.

And now’s a good time to do so, as I expect U.S. equities to remain more in favor with large investors seeking income and growth.

So many people are calling for a correction … which is precisely why we might not get one. With the end of the quarter fast approaching — and then the all-important fourth quarter just ahead — there is enormous performance pressure on underinvested fund managers who are concerned about global geopolitical risk and slowing European growth.

The S&P 500 is up about 7.5% year-to-date, and that’s the benchmark that almost all fund managers are measured against. Most hedge funds are lagging the S&P this year — and, therefore, it can be assumed that any and all dips going forward will be used as buying opportunities in efforts to catch up. The August rally caught a lot of professionals flat-footed; to make up for lost ground, those fund managers are likely to reach for small- and mid-cap stocks, as they offer more bang for the buck than large-caps.

Now, it’s certainly true that not as many of these stocks pay traditional dividends … but today I’d like to show you how you can manufacture an instant “dividend” for yourself by trading an up-and-coming Internet stock. Let’s get started.

My Buy-Write Recommendation for TrueCar (TRUE)

TrueCar (TRUE) is a hot, newly listed Internet company that has permanently changed the car-buying experience for consumers with its negotiation-free car buying and selling platform. Everyone knows that you are likely to wind up paying more than you expected at a dealership, thanks to sneaky tactics and hidden fees; instead, you can now go to TrueCar, which prides itself on providing a simpler and much more transparent experience. (I wouldn’t want to be a car salesman now that these guys have made a name for themselves with national TV ads.)

If you’ve been following my articles, a pick like this may surprise you. Unlike my usual high-yielders, the company doesn’t pay any sort of a dividend.

But what I’ve got in mind for TRUE is more of a short-term trade in which we create income for ourselves in the form of option premium, by executing a “buy-write” on the stock. In other words, we’ll purchase (buy to open) the shares and “write” (sell to open) calls against them.

Here’s the trade:

For every 100 shares of TrueCar (TRUE) you own or purchase at market, “sell to open” 1 TRUE Sept. $25 call for a net debit of $22.50 or less.

TRUE shares are trading at about $22.75, and the TRUE Sept. $25 calls are trading at about $0.50 per contract. Subtracting the targeted call premium you could collect from that stock price ($22.75 – $0.50) would result in a net debit of $22.25, lower than the figure we’re targeting ($22.50).

The sale of the calls at that $0.50 price brings in upfront income — our instant “dividend.” Then from here, the goal is to hold TRUE shares through September options expiration. I fully expect the stock to be trading north of $25 by then; if it is, the buyer of your TRUE Sept. $25 calls will want to “call away” your shares. (In other words, he or she will be purchasing TRUE shares from you at $25, for a slight discount to their market value.)

If all goes as planned and your TRUE shares are called away, your net profit will be at least $2.50 ($25 – $22.50), which translates to an 11% gain. Very nice, considering a lot of buy-and-hold strategies would take a lot longer to see that kind of appreciation.

Bryan Perry is the editor of Cash Machine, a newsletter focused on high-yield income investing with the goal of maintaining a blended total yield of 10% across two portfolios. And most recently, Bryan introduced Cash Machine Trader. With this service, he’s increasing the income stream potential even further by using covered call writing strategies to generate yield in the form of option premium — on top of capital appreciation income from well-known stocks.

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