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- Market Decline and the Battle Between Dividends and Options Premiums: A Strategy for Consistent Income
Market Decline and the Battle Between Dividends and Options Premiums: A Strategy for Consistent Income
Weekly Edition: February 26th, 2025
News Snapshot
Stocks struggle as S&P notches its fourth consecutive daily decline
Shaky Sentiment: Consumer Confidence Slips
Tech Stocks Lagging—Try Turning Them Off and On Again
NVDA Gears Up for Earnings—Investors Adjust Their Resolutions
TL;DR
The stock market took a bit of a nosedive on February 25, with the S&P 500 slipping below 6,000 and the Nasdaq getting hit hard—mostly thanks to struggling tech stocks. Consumer confidence also took a major hit, with the biggest monthly drop in nearly four years. Seems like Americans are about as confident in the economy as they are in gas station sushi. Inflation worries, weak retail sales, and some looming tariff talk all played a role, pushing investors into panic mode. Even the VIX, aka Wall Street’s "fear gauge," spiked, signaling heightened market anxiety as investors grappled with economic uncertainty and shifting policy concerns.
Meanwhile, Bitcoin fell below $90,000, marking its worst drop since August and highlighting the continued volatility in the crypto market. On a more positive note, Nvidia is set to report earnings, with expectations of a massive $38 billion in revenue. AI-driven optimism continues to support the stock, even as competition from China’s DeepSeek intensifies. While broader markets struggled, Nvidia investors remain focused on the company’s growth potential and its role in the evolving AI landscape.
This continued turbulence is a reminder of how important it is for options sellers to stay nimble. With volatility on the rise, premiums will increase as well, but this also means a higher risk for those holding positions.
“Good-To-Know’s”
Ex-Dividend Date - This is the day that the companies dividend allocations have been specified. It is essentially the date the stock begins to trade without the value of the dividend. Typically, the stock’s price drops by roughly the dividend amount on this date. If you want to receive the dividend of a stock, you need to own it BEFORE the ex-dividend date.
This is the 2024 Q1 Dividend Calendar for Ford as an example:
The dividend process begins with the declaration date on February 6, 2024, when the company announces the dividend amount, ex-dividend date, record date, and payment date. The ex-dividend date follows on February 15, 2024, marking the last day investors must own the stock to be eligible for the dividend—anyone buying on or after this date will not receive it. The next step is the record date on February 16, 2024, when the company finalizes the list of shareholders entitled to the payout. Finally, on the payment date, March 1, 2024, the company distributes the dividend to those who held the stock before the ex-dividend date.
Thought Throttle
We all want to earn consistent income in our portfolios. The first avenue that many investors turn to is bond’s (boring), and then dividend-paying stocks. While these can be solid mechanisms for consistent income, there is another alternative that is not as often considered. This is, of course, Selling Options (Strategically).
Selling options can provide investors with the potential for higher income through premiums, offering an attractive alternative to traditional income-generating investments. However, it’s important to note that this strategy comes with increased risk, as sellers may face significant losses if the market moves against them.
Most of us know how dividends work (at least high-level) and likely have a few dividend-paying stocks in our portfolio. We know that x times per year (commonly 4), we ‘receive a check in the mail’ with our dividend payments. The usual dividend yield is anywhere from 1% to 4% and is typically industry-specific. For example, Financial Services Companies generally offer higher dividends than Biotech Companies.
Dividends are also about as passive an investment as you can imagine. You literally just own the stock and the dividends are paid out to you. There’s little to no active management required, making it an appealing option for hands-off investors. The consistent payouts can be a reliable source of income, especially for long-term investors.
Options selling, however, does have an advantage over dividends, which is that they offer a higher risk-reward profile. They are riskier and could stand to make you more money. By selling options, you can collect premiums upfront, potentially boosting your income even in flat or volatile markets. And while options selling can provide higher returns, it comes with increased risks due to market volatility and the possibility of assignment.
Let’s look at some of the differences:
Dividends | Selling Options | |
|---|---|---|
Income Consistency | Regular, predictable (quarterly/monthly dividends) | Variable, depends on market conditions and strike prices |
Risk Level | Lower (especially with blue-chip stocks) | Higher (subject to market swings and assignment risk) |
Capital Requirement | Moderate to High (must own shares for dividends) | Varies (cash-secured puts need capital, covered calls require stock ownership) |
Return Potential | 1-4% annually (depending on yield and reinvestment) | Potentially higher (5% monthly if active, but riskier and depends on underlying) |
Tax Efficiency | Qualified dividends taxed at favorable rates | Short-term capital gains (taxed at higher rates) |
Compounding Opportunities | Dividend Reinvestment Plans (DRIPs) - automatic reinvestment of dividends into more shares | Strategic rolling of options positions; not passive, requires further analysis |
Time Commitment | Passive (Buy & Hold Strategy) | Active (requires monitoring, rolling, and adjusting) |
Downside Protection | Usually entrenched, mature companies | Limited—can help hedge but not eliminate downside risk |
Best For | Long-term wealth building, low maintenance | Active traders looking for consistent cash flow |
It is important to note that these methods are not mutually exclusive. You can sell options on stocks that pay dividends to juice the income received. Usually, however, more mature (less volatile) stocks are the ones paying the dividends, and since they have lower volatility, they also typically have lower premiums.
This is an example of options selling on Bank of America (BAC), a dividend-paying stock in the financial services industry.
On October 16th, 2024, Bank of America (BAC) declared that they would pay a dividend of $.26/share on December 27th, 2024. An investor decided that he was bullish on BAC, largely due to their consistent dividend record, and wants to pair this dividend with a covered call.
On October 17th, the day after the announcement, the investor purchased 100 shares of BAC at $42.80/share ($4280). He simultaneously sells a covered call expiring December 20th with a strike price of $46 and receives a premium of $52.
By December 20th, the call is OTM (Out Of The Money), so it expires worthless and our investor gets to keep all of the premium. He has also held the shares through the Ex-Date, entitling him to the dividend.
That following Monday, December 23rd, he decides to sell another covered call. He sells the Jan 17th $46 Strike Call option and receives a premium of $46.
On December 27th, the investor receives $26 in dividends ($0.26 per share x 100 shares) and goes on with their day.
By January 17th, Bank of America has increased to $46.64/share, and the sold call option is now In-The-Money. The investor is assigned to sell all 100 shares at $46/share.
Let’s see how much income, if any, the additional covered call generated:
The premiums for the sold calls totaled $98, the dividend was $26, and the captured capital appreciation was $320 ($46 assignment share price - $42.80 purchase share price x 100 shares). This totaled a profit of $444, or 10.374%, over the course of 92 days. That is an annualized return of 47.93%. Very good.
Compare this to the same scenario, but excluding the covered call. The investor would have bought 100 shares at $42.80 on October 16th, received $26 in dividends on December 27th, and sold 100 shares on January 17th at $46.64/share. This totals to a profit of $410, or 9.579%, over the course of 92 days. This is an annualized return of 43.75%. Still, not bad at all.
While selling covered calls on dividend stocks like Bank of America can be lucrative, it’s crucial to be aware of the downside. In volatile markets, stock prices can swing dramatically, causing the options seller to lose the premium they earned or even be forced to sell their stock at a loss.
One thing to keep in mind is that dividend capture strategies aren’t as commonly used these days due to the fact that the share price tends to drop by the dividend amount on the ex-dividend date. This drop can reduce the overall value of the trade, especially in the short term. Additionally, the strategy relies on the stock price staying relatively stable or increasing moderately, as significant price increases beyond the strike price will cap your gains due to the covered call. It is important to fully understand the trade before entering it.
In the comparison scenario (without the options), the investor sold the shares on the same day the call expired (Jan 17th) for comparison purposes, though this may not have been when the stock position would have been exited in a traditional dividend strategy. One of the advantages of owning the shares outright, without the use of options, is that there’s no expiration date to worry about, and the investor can hold the stock as long as desired for both dividends and potential capital gains. The return here highlights the potential for enhanced income generation through covered calls, but also shows that the trade-off involves the risk of capping upside potential.
While covered calls can provide a strong return, the strategy has its complexities, particularly with managing the timing of selling calls and the impact of stock price fluctuations. Investors should carefully consider whether this strategy suits their risk profile and income goals, ensuring they balance the potential for extra income against the possibility of missed growth opportunities.
Ultimately, the choice between dividends and options selling boils down to your personal risk tolerance and investment goals. If you’re looking for passive, long-term income, dividends might be the right choice. However, if you’re more comfortable with active management and higher risk for potentially greater rewards, options selling could be worth considering.
Relevant Quote I Like
“When you’re one step ahead of the crowd, you’re a genius. When you’re two steps ahead, you’re a crackpot.”
Throttle Q&A
Options premiums are typically taxed as short-term capital gains, meaning they are taxed at the investor’s ordinary income tax rate (Higher rate). In contrast, dividends can be taxed differently depending on whether they are qualified or non-qualified.
Qualified Dividends: Taxed at a lower rate (15%-20%).
Non-Qualified Dividends: Taxed at the ordinary income rate.
Because options premiums are taxed at the higher ordinary income tax rate, they are generally taxed more heavily than qualified dividends, which enjoy preferential tax treatment. The overall tax burden depends on the investor’s tax bracket and the type of account in which the income is generated. The taxation may not be a concern if held in qualified accounts (IRA’s, 401(k)’s, etc).
Expected Returns of Dividends and Selling Options
Dividends typically provide steady, reliable income, with yields ranging from 1% to 4%, depending on the industry. They are considered lower-risk but offer more predictable returns. On the other hand, options premiums can provide higher returns, especially in range-bound or volatile markets, as they depend on factors like stock movement and volatility. Many options sellers shoot for a return of ~5% a month, but due to the volatile nature of options, this is not always achieved. The returns are riskier and vary more.
Dividends: Steady income, moderate returns.
Options Premiums: Potentially higher returns, higher risk.
Compounding effects and differences
Dividends can create a powerful compounding effect when reinvested into additional shares, allowing investors to earn income on both their original investment and the new shares acquired. Options premiums can also be reinvested, but the compounding effect requires more active management and carries more risk.
Dividends: Natural compounding over time with minimal action.
Options Premiums: Active management for compounding, higher risk but potentially higher rewards.
In essence, dividends can be set up to compound passively over time, while options require active strategy execution to compound.
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Disclaimer
The information provided in this newsletter is sourced from reliable channels; however, we cannot guarantee its accuracy. The opinions expressed in this newsletter are solely those of the editorial team, contributors, or third-party sources and may change without prior notice. These views do not necessarily reflect those of the firm as a whole. The content may become outdated, and there is no obligation to update it.
We strongly advise you to consult with a financial advisor before making any investment decisions, including determining whether any proposed investment aligns with your personal financial needs.
