LEAPS Covered Calls

LEAPS covered calls are much like other stock covered call options that investors can use to generate cash income in their stock brokerage accounts, but with one important difference.  The difference is that LEAPS, or Long Term Equity AnticiPation Securities, have expiration dates longer than one year.  An example might help to explain how to use LEAPS covered calls to your advantage.

First, if you are not familiar with options trading, a call option gives the buyer the right, but not the obligation, to buy a pre-determined quantity of an asset, usually a stock or commodity, at the specified price (strike price), on or before the expiration date of the option contract.  A covered call  option is just a standard call option where the seller is covering the contract with securities that are already owned in their brokerage account.  LEAPS covered calls are standardized call option contracts with expiration dates over one year away, that are secured by the shares of stock that are already owned in the sellers trading account.  Since each LEAP option contract represents 100 shares of stock, these covered options can only be sold (also known as writing a call option) based on full 100 share increments of the underlying stock that the option is being written against.  For example, if an investor holds 200 shares of General Electric (GE) in their brokerage account, they would be able to write (or sell) 2 LEAPS covered calls.

The longer expiration dates that LEAPs possess give long term investors the ability to get exposure to long term price changes, with no need for a combination of shorter-term option contracts. Also, the premiums (price) for LEAPs are higher than for standard options in the same stock because the increased expiration date gives the underlying stock more time to make a large price move and for the investors to make a good profits.  Conversely, for the investor writing LEAPS covered calls, they get a higher cash payment up front for taking on the risk that they may be called out of their stock over the longer time frame contained in the covered LEAP contract.

One other characteristic that an investor considering writing LEAPS covered calls should consider is that the price decay of a LEAP call option is much slower than an option with a much nearer term expiration date.  For instance, if a call option with a strike price  equal to the underlying stocks current price only has a month to expiration, and the underlying stock price stays flat, the price of the call option will decline to nothing over the final month of the contract.  However, a leap contract will register a very minimal reduction in price over the same month, due to it’s longer time to expiration.

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Stocks That Pay Monthly Dividends

While you have probably heard about stocks that pay dividends every quarter, did you know that there are many stocks that pay monthly dividends?  When many income investors think about investing for dividends, they naturally look at safe, stable companies like McDonald’s(MCD), Proctor & Gamble(PG), and IBM (IBM), which have a long history of paying quarterly dividends.  These types of dividend stocks are usually financially stable, have a lot of liquidity so they are easy to buy and sell, and have enough income and cash reserves to cover their dividend payouts to investors every three months.

There are a couple of issues that investors in these type of quarterly dividend stocks should consider.  First, the investors income stream is exposed to a single company for each stock that they own, and second, depending on the mix of stocks in the investors portfolio, the dividend income can be very lumpy (i.e. most of the dividend money arrives in one month of the quarter, leaving the remaining two months with very little cash coming in.

Stocks that pay monthly dividends are an alternative that can provide regular, consistent, income to investors, and overcome the two main issues highlighted above.

First, monthly dividend stocks are typically traded on regular stock exchanges, and have enough liquidity for investors to easily buy and sell them.  Stocks that pay monthly dividends are usually trusts, closed end mutual funds, and other investment vehicles that actually own a portfolio of income producing assets.  This benefits investors because they get the diversification of the underlying portfolio owned by these companies, so investors are not as exposed to single company risk as they would be if they owned a single company that paid a quarterly dividend.

Second, since the income stream from stocks that pay monthly dividends comes three times as often as the cash flow from their quarterly brethren, the income is not going to be as lumpy.  This is a significant benefit for investors that need regular income, like retirees that need a passive source of retirement income to meet their monthly needs. 

One of the obvious items that investors considering purchasing stocks that pay monthly dividends over a company that pays a quarterly dividend is understanding the assets that are held by the monthly dividend company.  While this adds an extra research item, it is very easy to find this information in the standard government filings that publicly traded companies have to file with the SEC.

Stocks that pay monthly dividends are a great tool for people looking for consistent regular income.  Since these stocks may be new to you, just click on this link for a list of monthly dividend stocks.

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