Investors seeking to boost their yield on dividend stocks can opt to sell a call against their existing position or initiate a position by doing a buy-write on a particular stock.
A buy-write is when the stock is purchased and the investor simultaneously sells a call against the position.
"As people are looking to reduce their risk and still maintain some income, we feel buy-writes can be a useful enhancement to portfolios," said Ron McCoy a portfolio manager of the LOWS Fund on Covestor, the online investing company, and founder of Freedom Capital Advisors in Winter Garden, Fla.
"For each 100 shares that is purchased, one option is sold," he said.
Since Verizon (VZ) , the New York-based telecom, reported earnings in January, the company's stock has pulled back over 10%. At its current price of $48.50, Verizon has a yield of 4.8%.
Investors who may be concerned about more downside occurring could choose to do a buy-right and lower their cost to under $44 or about 10% underneath current prices, said McCoy, who recently bought the stock around $48.50 and sold the January 2018 $45 calls against his position.
If all four dividends are collected and the stock is called away in January, the return would be just over 8%. In his LOWS fund which is generating a return of over 6% year-to-date, McCoy has taken advantage of the pullback and sold the July $40 puts recently for $0.39.
A seller of a put is obligated to buy the shares up until the expiration at the strike price, which is $40 in this instance.
"It can be a way to generate more returns," he said. "Since Verizon currently trades at 14 times the current year's estimate and 12 times the forward estimates, it is cheaper than the overall market."
Using options when investors own a dividend-paying stock and reducing the cost basis can be a "clever way" to enhance the dividend yield, said K.C. Ma, a CFA and director of the Roland George investments program at Stetson University in Deland, Fla.
"The premise is that the stock needs to be in a low volatility phase during the period you intend to collect dividends from," he said. "Simply selling a call because of stock's dropping prices recently may be risky."
If selling a call to earn premium to offset the cost basis is the strategy an investor is following, it could backfire if the stock rebounds, Ma said.
"The call may be exercised and you will lose the upside capital gain, which is often more than the dividend yield of a typical stock, say 2% to 3%," he said.