Income Investors Will Look Very Smart with These Gains

Call it the "Summer of Pain." All the major indexes are down for the year, flirting with textbook "correction territory."

Utility stocks, as tracked by the Utilities SPDR ETF (NYSE Arca: XLU), have been among the hardest hit. The XLU ETF is now off an eye-watering 20% from its February 2015 highs.

The trouble is, the utility sector is a massive favorite among income investors, thanks to its stability and generous yields. XLU, for instance, pays close to 4%.

OptionsBut even that attractive yield won't come close to paring down the losses this sector has suffered recently.

And that has a lot of investors - particularly conservative income investors - nervous.

But... utilities aren't going out of business anytime soon, and that 4% yield still beats the broader markets.

And the simple play I'm about to show you will make sure you get paid all year while taking the bite out of some of the downside risk.

Dates to Know for This Strategy

As I mentioned, it's the attractive dividend yields that, at the best of times, make utilities and XLU so popular with investors.

It's easy to see why: You don't have to worry about timing the markets. You just need to pay attention to some key dates and collect clockwork profits.

There are four important dates to watch out for:

  • The Declaration Date is when the dividend payment is announced by the company.
  • The Ex-Dividend Date is when you must own the stock in order to receive payout.
  • The Record Date shows an accounting of all shareholders on record to receive a payable dividend.
  • The Payable Date is the big day, when the dividend is paid out to shareholders.

As a long-term income strategy, this is tough to beat. But, as we've seen with XLU, the problem is that stocks are dropping faster than a year's worth of dividends can cover.

Now, there are two ways to deal with this problem.

One approach (call it the "Daddy Warbucks" strategy) is just to buy more and dollar-cost average into the position.

That's fine if you're rich, but for most investors and retirement savers, spreading risk means not putting too much capital to work in any one stock or sector.

But there's a better way to "juice" those returns without adding any more capital to the trade...

Our Play: The Classic Covered Call

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Tom Gentile will show you exactly how to make this trade in his video. Just click the image to watch it now.

We can reasonably expect utilities to rebound - and nicely, at that - over the course of the next year. As I said, utilities aren't at risk of going bust anytime soon, and economic conditions prevailing in the United States right now are telegraphing better, not worse, times ahead for these companies.

This is a classic, easy-to-make options trade. We'll sell a simple call option on shares we already own to bring in additional income throughout the life of the option.

This is simply the best way to increase the probability of success even as we slash our risk.

It will also reduce the overall cost of the investment and cut the breakeven on the investment over the course of the year.

Now, for every 100 shares of stocks we own, we will look to sell one call option either at or slightly out of the money to receive the most premium we can get - along with all the other return.

Then we just sit tight as the stocks and options move until we get closer to expiration to receive the full income from the options we sold against the stock.

Most people trade covered calls on a monthly basis to collect income off of stocks they may own, but utility stocks are a little different.

You see, in most cases, it doesn't pay to write monthly covered calls on your utilities; the premiums are usually too small.

But when selling a longer-term premium, things look very different indeed...

Let's take a look at the options on the XLU that have one year to expiration, particularly the XLU January 2017 $41 (XLU170120C41) calls, and create the following covered call...

Options

First, you'll notice that for 100 shares, the stocks are covered with one call option.

And those options brought in premium as well. In fact, this premium reduced the cost of all trades by about 7.5%.

OptionsThe risk graph on this looks a bit different than simply owning the stock, but remember: You're paid a premium to sell the calls - a premium that just reduced your drawdown on this position by the amount received for the call options.

This really helps cushion the risk of the trade.

Now, what this chart doesn't show is the roughly 4% dividend that XLU is paying out right now.

And when you couple that with the options trade I just showed you, you stand to collect a cool 12% over the next 12 months for very little effort.

That's a great return from a sector that's in the midst of an historic pounding, and it certainly beats the negative return of the broad markets right now.

Other investors might not see the upside here, or the protection this offers, but you'll look mighty smart while they lose their shirts.

Tom is currently showing his Power Profit Trades readers how to make a 100% return in just 30 days on the small movements of one of the biggest, most valuable companies in America. Click here to join them - you'll get this high-profit strategy and new recommendations each week at no charge.

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