You looking for a long term investment vehicle with a chance of a decent return? You might want to think about buying high dividend stocks with low P/E’s. Think conservative stocks.

When I say low, I’m thinking roughly in the “less than 20” rule of thumb. That being said, you need to do your research. Each industry has different standards for what P/E is considered good.

Take a look at DOW Chemical (Symbol: DOW). With a P/E of 18.6 and a dividend yield of 4.37%, it looks mighty fine to me. It’s even off it’s high of roughly $40 and it’s trading right around $29.32 a share today. This is a very viable long-term play.

I usually take my research a bit further by researching two things. How does revenue look? Is it growing or declining? It might surprise some to know that most likely you are looking for little change in revenue in this type of investment. You want consistency (maybe with a little bit of gain). No spikes and no massive growth is required for a great return on investment.

The revenues and net incomes look just about perfect to me, but what about the option chains?

Why take a look at the option chains? Two reasons. To see the overall market sentiment and to see if it would be worth writing cover calls on your stock.

For instance, the stock is trading for about $29.32 a share, and you could write a call option for Oct 20th, 2012 (see first picture) at a strike price of $31 for $.32 for each contract. Remembering that contracts are in 100’s of shares and should be multiplied by 100, you would earn $32 per contract sold.

Why would you want to sell a cover call?

If you are in the strong for the long-hall position, but believe the stock will not change in price or possibly have a slide in price from now until the expiration date, you can make a premium and/or hedge your losses. Let’s say you buy 1000 shares of DOW chemical at $30 a share and write 10 contracts for a $31 strike price option for Oct 20th, 2012. You would instantly receive a $320 premium (minus commissions).  If the stock doesn’t go above $31 from now till the expiration, odds are the option buyer will not exercise and therefore you will have gained his or her option premium.

Don’t I lose out if the stock goes up after writing my option?

Yes and No. If the stock goes up to $40 a share after you write your $31 strike price option, then yes, you would have made more money simply owning the stock (because the option owner will take the stock from you at $31 a share), but if you sell the option and the stock goes to $31.20, the option holder will still end up giving you $31 a share for the stock you only paid $29.32 for in the first place. Add the premium you initially received ($.32) and add in the $1.68 of appreciation versus today’s market price, you made $2.00 even on you $29.32 (6.8% in less than a month!).

Where is the Break-Even on Cover Calls?

In this situation, anything over $31.32 you would have been better to not write the cover call. If it finishes anywhere below $31.32, you made out. Note: Sometimes option holders will exercise to capture dividends. This should be fully researched and understood before any cover call writing.
What if the stock goes down?

The idea here is that you are long on this stock, and therefore don’t really mind a little downturn movement. If you decide to write cover calls, the premiums received will mitigate losses.

Disclosure: I currently own call options on DOW Chemical that expire in Jan 2014. I am currently bullshit with a target of approximately $32.50 a share.

Disclaimer: For entertainment purposes only. Nothing in this article or website should be used for any decision making of any kind. Consult professionals.

Filed under: InvestingOptions

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