Is there such thing as a perfect income stock?
I get quite a few emails from options sellers; here’s one of the most common: “The premiums on this stock look great. What do you think of the company?”
That’s what I call “premium chasing,” and it’s one of the biggest mistakes you can make as an income trader.
There’s an inherent tension when selling options for long-term income… The volatility that drives premiums up is the exact same volatility that can negatively impact your portfolio value.
What’s a trader to do?
Start by choosing the perfect income stock.
Finding the perfect income stock starts with choosing the perfect company. Then you simply need to find the right options to sell. In other words, THIS is question traders should ask: “The company looks great… What do you think of the premiums?”
The Perfect Income Stock
For the typical income investor, the search for the “perfect income stock” begins with a high dividend yield. The average annual yield of a stock in the S&P 500 is only around 2%, which is very low by historical standards.
But high dividend yields may be unsustainable or can be a sign that a company is in distress.
Selling options for income, on the other hand, can generate significantly higher income. For instance, it’s completely reasonable to expect a 25% annual return from selling options, even if the underlying stock goes nowhere.
And like I said before, it all starts with a great company. Here’s what to look for…
If you're an investor who relies on their portfolio for income, you need to watch this newly released video training series:
Picking Great Companies
A great company delivers above-average growth based on Wall Street’s preferred measures. Example: The Street’s crucial metric for Netflix (NASDAQ: NFLX) is subscriber growth, NOT the company’s bottom line.
A great company has a unique or dominant position in the market; it’s the idea of an economic moat. Having one makes the stock more resilient—and that’s exactly what you want in a long-term income pick.
Need another solid example? Look at Apple (NASDAQ:AAPL). It’s the clear leader in smartphones, tablets, apps and music. And while it’s no longer a growth stock, Apple is one of my favorite income stocks.
Finally, a great company needs strong management.
I look for a stock that’s undervalued. You can gauge value by using the P/E ratio, the PEG ratio or other metrics. Whichever you use, the key is to see where a stock stands in relation to its sector and the market as a whole, as well as compared to the stock’s historical multiples.
Delta Airlines (NYSE: DAL) illustrates this point. It has a trailing P/E of 8.79. This is more than 50% discount to the S&P 500.
CEO Ed Bastian noted that five of the company’s 10 best revenue days in its history occurred in the past month. This is likely due in part to the fact that Delta does not operate the Boeing (BA) MAX, which was grounded following deadly crashes. Problems with the MAX have been hitting competitors including Southwest Airlines (LUV) and American Airlines (AAL). And I believe Delta will retain some of its recent market share gains even after the MAX issues are resolved.
Shares ran up following the earnings announcement but remain undervalued. The combination of a low valuation, terrific fundamentals and large option premiums make DAL a great put-selling candidate.
Before I get into nitty-gritty details about selecting and selling options, I want to share another one of my favorite income stocks …
Income from Digital Payments
Mobile payments is one of the biggest trends for investors to capitalize on starting now.
And digital payments processor Square Inc. (NYSE: SQ) is my hands-down favorite company in this space.
Square has a robust and growing suite of applications aimed at entrepreneurs, small businesses and consumers. These include Square Payroll, Square Capital, Square for Restaurants and the Cash App.
The combination of Square’s easy-to-use front-end devices and powerful point-of-sale software is translating into rapidly growing market share.
And third-party data released recently showed that, for the first time, downloads of the company’s Cash App surpassed that of PayPal’s Venmo, the perceived leader in the peer-to-peer payment space.
A Perfect Income Stock to trade
When selecting a perfect income stock to trade, I look for a market leader with the following benefits:
- A compelling business model
- Above-average growth
- A strong, identifiable brand
- Superior management.
Square checks all these boxes.
It is a high-growth company and a high-beta (read: volatility) stock. This combination gives us the opportunity to sell well-out-of-the-money puts for excellent premiums.
Square was an absolute dream for income investors. For the last 12 months, we’ve traded Square 28 times in my Options Income Blueprint service.
And we are 28 for 28 in winning SQ trades.
Active traders who sell puts on the stock every week have the chance to make between 175% and 206% a year.
About The Author
Michael Shulman is a 30 Year Veteran of the financial markets – as a trader, a financial analyst, a financial writer and most recently as an educator.
He has published two books – Sell Short and Made in America – both of which can be found on Amazon.com, and he is a frequent contributor to reputable financial sites like Seeking Alpha, MSN, MainStreetInvestor, and Traders Reserve.
Most importantly, since 2010, he has dedicated himself to teaching income investors how to get more income from their portfolios using simple yet safe options selling strategies which produce income every week. This approach was developed from the ground up in Mr. Shulman’s own accounts, his goal to develop a strategy that cannot be replicated by institutional investors of any size and therefore independent of fads and trends that change too often to provide a consistent approach for individual traders.
His trade recommendations in his Options Income Blueprint, Perpetual Income Portfolio Club and Income Masters services maintain a 98% success ratio, meaning his trades produce the expected income 98% of the time. No one’s perfect.