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High-Yielding Dividend Captures: Right Companies Can Offer Superior Returns

NEW YORK ( TheStreet) -- Many high-quality companies offer quarterly dividends to investors. Dividends may be a great source of income because with each payment shareholders can lower their investment cost, as long as they are shareholders on the required day of record.

In my portfolio, although much of the gains will come from dividends, option decay will provide a big part of my gains. Option decay, or Theta, is the loss in time premium between two dates. This is especially true in lower-yielding stocks, since higher-yield options have lower-time premiums, all else being equal.

Kraft
When picking dividend stocks using an options hedge, companies such as Kraft become low-hanging fruit.

Let's say I write an option today to you for $1 with an expiration in two months. After one month, you would expect the value to drop in half (not actually, but you get the idea). If I write a covered call with 30 cents in time premium and the option buyer exercises the option in front of the ex-dividend date, I get to keep the time premium paid (because the buyer is exercising).

Also, the longer I maintain a covered-call position (like two weeks with a front-month option, for example) the lower the time premium is worth (all else being equal).

A requirement I have is be able to sell a call option in either the front, or first back month that is in the money, and with enough premium that I will not object to an early exercise notice (which does happen from time to time, but is profitable if everything is done according to plan).

It is important to sell the call option hedge at or near the asking price for at least the minimum amount over intrinsic value, otherwise I don't want it.

My last step (completed before making a trade on the same day) is to check company announcements, and news sources for possible price moving events. This is especially critical during earnings season.

Consider:

St. Jude Medical

St. Jude Medical (STJ - Get Report) is dedicated to making life better for cardiac, neurological and chronic pain patients worldwide.
Yield: 2.44%
Dividend amount: 23 cents
Ex-dividend date: June 27
Beta: 0.74

Strategy: Buy St. Jude Medical stock and offer to sell the July $35 strike or lower call for 37 cents over the intrinsic value. I will try to close out the trade with a gain of near 21 cents, plus dividend.

If my shares are called away before trading ex-dividend (resulting from the option buyer wanting the dividend), I gain about 37 cents. The most I can make is 60 cents if I hold the covered call through option expiration day and the stock gets called away.

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