We need to keep our money working for us at all times—in the safest way possible. Sometimes, this means using a high-yield savings account, investing in dividend stocks, or even trading options.
I recently discussed selling covered calls and cash-secured puts versus buying dividend-paying stocks. The conclusion was that trading options can be much riskier but also more lucrative.
Today, I want to examine a hefty $25,000 portfolio and determine which path is better: options or dividends. We will use the options wheel strategy versus income investing to see how it plays out. Let’s begin.
I’m Living My Dream Life with Dividends
What is income investing? I earn at least 10% dividends on my invested capital as an income investor.
I use six income investing products to accomplish this feat: business development units, dividend ETFs, mortgage REITs, closed-end funds, preferred shares, and high-yield dividend stocks.
Of these, my favorite type of income product is closed-end funds. I choose CEFs that pay me a monthly high yield and have proven track records.
I have a $25,000 portfolio composed mainly of CEFs; it pays me roughly $340 per month. Most of this income comes from Eagle Point Credit (ECC) and Oxford Lane Capital (OXLC).
Both of these CEFs specialize in purchasing collateralized loan obligations, or CLOs. Most investors consider these risky, but they are much safer than trading options.
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I love CEFs and other high-yielding products because I can let the professionals do the tough work for me. They are purchasing junk bonds, CLOs, and business loans to earn high yields for me.
What is the options wheel strategy? On the other end of the spectrum, the options wheel strategy is only effective if you become a strategic options investor.
The options wheel strategy involves selling cash-secured puts on stocks you want to eventually own. You set the strike price low on the puts so that if you do assume shares, they will be at a bargain basement price.
Eventually, you will assume shares of the underlying stock. At this point, you will sell covered calls, setting the strike price high above your cost basis. When someone purchases your shares, you will have made a substantial profit on these shares.
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So you bought low and sold high—seems easy enough. What’s so challenging about performing the options wheel strategy?
After trading the options wheel for six months, I found out the hard way. I let my greed take over. I wasn’t selling puts at low strike prices, nor was I selling calls at high strikes.
You earn the highest premiums the closer to the share price you set the strike price. As a beginner, you will see massive premiums, especially during earnings calls.
That’s where greed comes into the room. At some point, you will be underwater on your cost basis, which is where fear enters.
Say you assumed 1,000 shares of Palantir (PLTR) for a cost basis of $22 each. However, the current price is $20. To make a profit, you would need to sell calls at a strike price of $22.50, which would pay you a low premium.
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If you get greedy and set your strike at $20.50 (hoping the price will go down), you will live in fear for one month. It’s not fun; trust me.
Controlling your fear and greed. So, the main difference between the options wheel and dividends is how much involvement you want in the process.
You can calmly and efficiently collect (passive income) close to 15% yields from ECC and OXLC. Or you can earn much higher annual returns from the wheel. Let’s look at what we can do with $25,000 in our options wheel portfolio.
Palatir’s current share price is $22.45, so let’s start by selling some cash-secured puts. Remember, we want to set the price low. We can set the strike price at $21 and earn $0.42 per share.
We can purchase 1,100 shares, so we need to set aside $23,100 to sell 11 cash-secured puts. That would net us $462 (1,100 shares x $0.42 each).
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Now, let’s find the annual return. We would take $462 x 12 to see the total premiums we earn over the year, which is $5,544. Now, divide $5,544 into $23,100, and we have an annual return of 24%.
However, if we assume shares, the premium on covered calls is much higher than puts. To sell calls safely, we would be looking at around $0.62 per share.
In theory, you could safely earn 30% returns from the strategy. You would need to wait at certain parts of the year to let your cost basis catch up to your share price.
Is it worth it? So, would you like to passively collect 15% or actively earn 30%? That’s a question for you to ask yourself.
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I love collecting dividends because they are predictable and consistent. However, if you position your options trade correctly, you don’t have to worry about the results.
As long as you set your puts low and calls high, you will usually be a winner. In the worst-case scenario, you must wait for your cost basis and the share price to align.
The case for both. The best option is to have both strategies. Learning how to make money from thin air is always a good idea.
I love dividends, but someone else is doing the legwork for me. For options trading, I must do the research and make the vital decisions that can help (or hurt) me.
I am a passive investor, but I understand sometimes the market will not go my way. There may be a time when I need to generate 30% returns.
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If I had a $25,000 portfolio, I would allocate $20,000 to income investing. With the other $5,000, I can slowly grow my options trading portfolio.
That way, I get the best of both worlds. I have consistent dividend income hitting my account every month. But I am also generating options-trading income while learning my fear and greed cycle.
Conclusion. Don’t wait until you need money to start trading options; that’s the wrong time. Your greed factor will be too high.
Most people believe income investing is risky because of the high yields. However, you just need to trust the professionals to generate your returns.
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On the other hand, the options wheel will keep you on your toes. You will have to fight your greed and fear at every turn.
You must find a way to make peace with your trades: that’s the true power of trading options. You are taking control of your financial destiny, one trade at a time.
You can put your premiums in a high-yield savings account, invest in dividend stocks, or reinvest into the options portfolio to grow it. It’s entirely up to you.
I am an 85% dividend investor, with a hint of options trading. I love the thrill of making my money work for me, but I don’t want to risk it all. What kind of investor are you? Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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