I previously wrote an article on Why I Stopped Investing In Dividend Stocks.
And sure enough - dividend investors got pretty upset..
...but here's the fun fact, I used to be a dividend investors too. In fact, that dividend portfolio was about $20,000 and giving me a 5% dividend yield on cost and the dividends were consistently growing.
I have since liquidated all of the positions and in this blog post - I am going to explain exactly why.
But first thing first - I need to explain what I define as dividend investing. (Just so we are on the same page.)
What Is Dividend Investing?
The analogy is this.
Being a dividend investor is if you bought a golden goose that lays golden eggs...
A dividend investor will never sell that golden goose. You will just want to keep getting the golden eggs.
So what defines as dividend investing follows these two criteria:
- Stock pays dividends (obviously).
- You invested in the stock for the sake of dividends.
You might think that point 2 is redundant.
However, it is actually important to realise that, because it determines your exit plan.
The only reason why you would want to sell away the golden goose is if it stops laying the eggs (i.e. stop paying dividends)
So what's the trouble with dividend investing?
Any capital appreciation of the stock are only bragging rights (ouch).
Why? Because they are only paper gains - and a dividend investor usually have no intention to sell their stocks to realise these capital gains anyway.
(Remember, they want to keep collecting their golden eggs! So they wouldn't sell their goose.)
However, it is not all doom and gloom. The good news is...you can get realised gains from the cash dividends that you have collecting.
Why I Stopped Dividend Investing
So here's the real reasons why I stopped dividend investing.
- Capital appreciation are only bragging rights (since you wouldn't sell the shares..)
- Dividend stocks usually don't appreciate much (explained in video below).
- The dividends collected are only meaningful when you have a larger capital base.
What does point 3 means?
Well, if you only have $10,000 - a 5% dividend yield will only give you $500 per year.
(That's barely enough to become financially free.)
Sure, you can bring in the concept of constant contribution and compounding effect - but these concepts are not exclusive to dividend investing. They could be apply to value and growth investing as well.
However, I know that there are investors out there who already have substantial capital - and they are looking to just get cash flow from their investments.
And this is where the options milking cycle comes in.
The Options Milking Cycle
This is the entire process of the Options Milking Cycle.
The most important step is the first step - Identify profitable companies.
This is why I keep stressing on the 8 Point Checklist, so that you can filter out the poor quality investments.
I want to show you a case study of this strategy using one of my investments, USNA.
I had my eyes on this stock in 21 Feb 2020.
So I decided to sell a put option at a strike price of 70 and collected a premium of $235. The option expiry is in one month.
Important Note: When you sell a put option, it means that you promise to buy 100 shares of the underlying stock at the strike price anytime before the expiry date.
In return, you are paid a sum of premium for making this promise.
In this example, it also means I promised to buy $7000 of USNA shares. You need to have $7000 of cash set aside to avoid the risk of a margin call.
Let's take a look at the returns.
I promised to buy $7000 of USNA shares, and I got paid $235.
That's already a 3.35% return - in a timespan of a month!
(See why I don't bother with dividend investing now? I don't think there are any dividend stocks that will pay you 3.35% in cash return in a span of a month)
So there are two outcomes when you sell a put option.
- 1The stock is above the strike price at the end of expiry, your option expires worthless. You simply keep the premium. You can then choose to sell the put option again.
- 2The stock is below the strike price at the end of expiry, your option gets exercised. You will fulfil your obligation to buy 100 shares. You still kept the premium. You now own 100 shares.
In either scenarios, it is important to remember that you do pocket the premium.
Now, what happens after the option gets exercised?
Well, I now own 100 shares of USNA.
I then sell a call option at the exit price - and collecting another $145 premium again.
That's a total of $235 + $145 = $380 worth of cash flow.
The returns is over the $7000 promised capital is 5.4%.
(That is over the span of two months.)
Important Note: When you sell a call option, it means that you promise to sell 100 shares of the underlying stock at the strike price anytime before the expiry date.
In return, you are paid a sum of premium for making this promise.
In this example, it also means I promised to sell 100 USNA shares. You need to have 100 shares to avoid short selling the stock.
So there are two outcomes when you sell a call option.
- 1The stock is below the strike price at the end of expiry, your option expires worthless. You simply keep the premium. You can then choose to sell the call option again.
- 2The stock is above the strike price at the end of expiry, your option gets exercised. You will fulfil your obligation to sell 100 shares. You still kept the premium. You can now sell the put option again.
That sums up the entire Options Milking Cycle - and it gives much more cash flow than the normal dividend investing.
These are the trades that I did for USNA and have collected around $1,415 in option premium - and I will keep repeating the milking cycle to siphon cash flow out from the investment.
Conclusion
The options milking cycle was a strategy that I designed for those who have a larger capital base and looking to create passive cash flow from their investments.
To put it bluntly, this strategy is not suitable for those who have a smaller capital.
Because you need the capital in order to be able to sell cash-secured puts.
This is why it is important to start small, and learn the right skill sets to grow your portfolio so that you are able to execute these strategies.
To do that, you need to understand how to find:
- A quality company
- the entry price
- the exit price
I covered this in depth in my free resource, the Stock Investing Hub.
However, if you are looking to take action fast, you can also check out our Profitable Watchlist Challenge, which is our implementation workshop - where you will be challenged to build your own profitable watchlist.
Find out more about the challenge here to see if its a right fit for you.