Is covered call writing on dividend stocks the holy grail for the semi risk averse investor?

Here is my point, behavioral finance these days teaches corporations, goverments and people all kinds of tricks that can help people make the right decision where they ordinarily dont. Some of them are related to saving and investing. What I'm saying is that covered call writing on dividend payers might be one of such tricks. While, in theory, these people might be better off indexing and holding things forever, they usually dont. As Buffett says, ETFs tend to make that worse as the liquidity encourages people to be more active in timing the market (so that 2% to 8% diff in mutual funds, could be worse in ETFs).

I'm suggesting that buying good dividend payers (whether in an ETF or with a diversified basket) and writing calls on them could potentially help SOME of those people. The extra income (both from the higher dividends and from the call selling) SHOULD help some of these people as it accumulates and provides them with a cushion for market drops. How do I know this? I know it affects me and I'm supposed to be a pro, when something is providing income, psychologically it makes easier to hold because you have all that past income and you can SEE how you will 'earn your way' out of a hole. Cash dividends and premiums earned in an account feel real, PEs and earnings yields don't. This effect is probably even bigger on the average person.

Overall, its a strategy that outperforms (especiall if done in a tax sheltered account) during market drops, exactly when people make their biggest mistakes (but more importantly, it does regularly paying the investor). So it should be part of personal finance but of course, economists and personal financers consider options gambles or risky and say people should avoid them, they should chase the index instead. This is especially a problem given the high valuation of US equities. The chance of a bigger drop has increased and people are being driven to the slaughterhouse. Little tricks might be just what people need to avoid that slaughter

Will that work on everyone? No, but it should work on some people
 
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Daal said:
Here is my point, behavioral finance these days teaches corporations, goverments and people all kinds of tricks that can help people make the right decision where they ordinarily dont. Some of them are related to saving and investing. What I'm saying is that covered call writing on dividend payers might be one of such tricks. While, in theory, these people might be better off indexing and holding things forever, they usually dont. As Buffett says, ETFs tend to make that worse as the liquidity encourages people to be more active in timing the market (so that 2% to 8% diff in mutual funds, could be worse in ETFs).

I'm suggesting that buying good dividend payers (whether in an ETF or with a diversified basket) and writing calls on them could potentially help SOME of those people. The extra income (both from the higher dividends and from the call selling) SHOULD help some of these people as it accumulates and provides them with a cushion for market drops. How do I know this? I know it affects me and I'm supposed to be a pro, when something is providing income, psychologically it makes easier to hold because you have all that past income and you can SEE how you will 'earn your way' out of a hole. Cash dividends and premiums earned in an account feel real, PEs and earnings yields don't. This effect is probably even bigger on the average person.

Overall, its a strategy that outperforms (especiall if done in a tax sheltered account) during market drops, exactly when people make their biggest mistakes (but more importantly, it does regularly paying the investor). So it should be part of personal finance but of course, economists and personal financers consider options gambles or risky and say people should avoid them, they should chase the index instead. This is especially a problem given the high valuation of US equities. The chance of a bigger drop has increased and people are being driven to the slaughterhouse. Little tricks might be just what people need to avoid that slaughter

Will that work on everyone? No, but it should work on some people
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There is no data to back this up and in fact, the data shows otherwise. If what you are saying is true, then by definition anyone who has been long since the 1990's let's say surely won't panic since they made all these profits since then. Heck the ES was at 2500. Surely they would feel "comforted" by all the profits they have raked in over the years. But yet they don't, despite being up thousands of percent on their money, they still panic right on schedule.

Daal, if you have studied behavioral finance, and I have, you would also know that people are more willing to lose money they don't have then money do they have. Meaning that if one has a $100 and they start investing today and lose $20 it hurts to some degree but not nearly as much as starting with $100 then making $20 to get to $120 and then giving all that $20 back. There is much more pain from giving money back. This puts a knife in your theory that people are comforted from cashflows from dividends and call premiums. This is also why very wealthy people (top 1%) usually don't invest in the market or why they only invest conservatively with an emphasis on "protecting" their capital vs "growing" their capital.

As the old saying it goes, it's much worse to be rich and lose it all then to never have been rich in the first place. The saying is true my friend and THAT is behavioral finance. Good day.
 
Daal said:
The buy write index was down 39% in 08-09, thats less than the 57% of the SPX(and you just said that SPY is a good div payer). That could be the difference between a huge mistake/panic sell and someone sticking with a strategy (unless you want to claim that additional losses produce no extra pain). I suspect a buy write on the DIV was probably down by a good deal less than the ETF (had it existed back then)
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Don't mistakenly panic sell then. Long term risk adverse investor is buy and hold for the most part so if you cannot sit through down markets where you keep adding in then you should stay out of the market directly.
 
Jones75 said:
That's exactly what happened to me, and for that reason I no longer entertain covered calls.
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That happened to me, then i sold OTM put, repeat until assigned. What goes up, eventually comes down. Worked out really well...
 
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Maverick74 said:
There is no data to back this up and in fact, the data shows otherwise. If what you are saying is true, then by definition anyone who has been long since the 1990's let's say surely won't panic since they made all these profits since then. Heck the ES was at 2500. Surely they would feel "comforted" by all the profits they have raked in over the years. But yet they don't, despite being up thousands of percent on their money, they still panic right on schedule.

Daal, if you have studied behavioral finance, and I have, you would also know that people are more willing to lose money they don't have then money do they have. Meaning that if one has a $100 and they start investing today and lose $20 it hurts to some degree but not nearly as much as starting with $100 then making $20 to get to $120 and then giving all that $20 back. .
More...

What the example is not taking into account is that its not about analyzing that pain in an absolute basis but RELATIVE to the pain of a similar situation.
Its about going from $100 to $120 with large positive carry, compared to going from $100 to $120 with a small positive carry or a negative carry. Then losing it.

What's more, the carry of covered calls is counter-cyclical, since premiums go up in market drops, the investor will be paid more just at the time where he most needs it (when he is likely to make a big mistake). Looking at JNJ right now wont capture this element.

So its a carry that increases doing those money losing periods (likely more than offseting any pressure in dividends, a fair assumption in case of US stocks), whereas the 2 other strategies give you nothing (or perhaps, only the dividend cuts with no offset)

But there is more, the total drawdown is also lower with that first strategy. I have never seen a behavior finance study that proves that losing more money (when you are already losing money) makes no difference to the pain level of people. I would be shocked if that is true, it goes against all my experience. Especially if the losses are spaced out (in studies, it all happens in a day or two, whereas in the markets, an investor can be tortured for months/years, at some point they might just give up in disgust)

So to sum
-The strategy has a larger positive carry compared to others. The carry is counter-cyclical and helps the investor when he needs the most help. It is also a lot more "real" (everybody understands cash in the account) then a magical capital gain that fluctuates
-The strategy delivers smaller drawdowns. It helps the investor when he needs the most, decreasing the amount of financial stress he will face at the same he is most likely to make a mistake. This is specially important given that it looks likely that people systematically over estimate their risk tolerance (yet they still want to be 'in the market').
-There is a third element that I didnt mention before which is the urge people have to 'do something' in weak markets periods. This strategy gives them something do to (collect inflated premiums), wheareas the other strategies give you nothing which might induce the person to sell

I dont think these nuances have been captured in a behavioral study before.

Now, can you honestly say you it if 10-20-30% of the population were more likely to stick the first strategy that would be some HUGE surprise? It would be just what one would expect!
 
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The Buy-Write strategy on Dividend Paying stocks will generate additional cash-flow, but is not generally a beneficial (on the long term) investment strategy. The main reasons would be:

- Quiet dividend payers do not offer much in the way of premium. You will collect a small premium and sacrifice the possibility of a sudden big upside move.
- If it moves up (and often enough its the 'big' sudden moves upwards where most of the gains are made), those gains are not realized. Resulting in a pure premium collection strategy (no equity gain).
- If it moves down, you enjoy the pure premium. But if it keeps doing this for years, you'll eventually be sad you are holding a bad stock :(

That being said, I think you are on the right line of reasoning, but need to flip it around a bit:

Do not look for dividend payer stocks to generate buy-writes on. Look for good stocks or ETFs to write buy-writes on that happen to offer a dividend.

In other words: The focus should be on finding stocks/ETFs that generate a good return by doing buy-writes on, regardless of their dividend. In the event that the stock does not get called away and you hold it longer than expected, at least you know you will get a dividend which will make the pain less.
 
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