When choosing high dividend stocks to buy, key analysis tasks are often omitted. Questions such as "Does this have any future growth potential?" or "Is it a very risky equity poised for a big decline?" are important, but sometimes overlooked nonetheless. But even if the trader does not want to do the necessary fundamental and technical analysis due diligence, certain steps can be taken to automatically reduce the risk exposure.
One such task an investor in high dividend stocks can take is to create a married put position to insure against large losses if the stock turns down to the downside. Once a high dividend stock has been identified, the trader can construct the married put position by purchasing shares of stock in 100 lot increments, and, for each 100 shares of stock, purchasing a put to limit losses to the downside. The investor still receives the regular high dividend, participates in further growth to the upside while at the same time minimizing the risk exposure involved in owning the stock.
This is a much safer approach when trading high dividend stocks, which can often have a lot of risk associated with them. In addition, to using the married put the options strategist can apply some other options strategies to not only reduce the risk but also generate more income as well. For instance, another way to add to the position and bring in more premium is to sell covered calls particularly after the high dividend stock has had a nice move to the upside.
By selling an out-of-the-money covered call after a rise in price brings in more income in addition to the regular dividend payouts. Also, the premium brought in from selling the covered call can be used to amortize the cost of the put which is the "insurance policy" if you will by virtue of initiating the trade as a married put. Essentially what the trader has done at this point is to turn the position into what is called a collar strategy.
It is important when adding this particular approach that the options strategist uses an out-of-the-money call because the objective is not to be called out, so the high dividend can continually be collected. This requires the trader to get a clear view of key support and resistance zones for the underlying high dividend stock being traded.
These are the most straightforward strategies that can be employed on high dividend stocks. But rest assured that, just like with other stocks, the trader can employ some othersâsuch as the put ratio backspreadâto protect the position, or for that matter any combination strategy which yields an attractive risk-to-reward profile. As always, make sure you do the necessary homework before entering the trade.
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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