Double The Yield On A 12.8% Yielder?! Here's How

January 24, 2014

Real estate prices are rising, and in many cities, are back to where they were before the 2007-2008 housing market crash. And mortgage rates are still quite low on a historical basis.

American Capital Agency Corp. (Nasdaq: AGNC) invests in residential mortgage pass-through securities and collateralized mortgage obligations for which the principal and interest payments are guaranteed by the U.S. government or a government-sponsored agency.

Structured as a real estate investment trust (REIT), it distributes at least 90% of its taxable income to its shareholders. Here is what AGNC looks like over the past year:

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The stock is now above its 20-day (red line) and 50-day moving averages (blue line). Also notice that the red line has started to penetrate the blue line, which tells us momentum is currently on the upswing.

Next is a chart comparing AGNC (green line) with the Dow Jones Equity REIT Index:

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As you can see, the sector exchange-traded fund (ETF) is also on the upswing, but at a faster rate than AGNC. Therefore, AGNC has the potential to catch the index's momentum.

On the fundamental side, the consensus earnings per share (EPS) estimate for next year is $2.58, giving the stock a price-to-earnings (P/E) ratio of less than 8. That is less than half of the sector average of 16.4.

AGNC pays a $0.65 quarterly dividend, which amounts to a current yield of 12.8%. But we can turbocharge the income on this high-yielding stock with a covered calls strategy.

A call option is an option to buy or sell shares at an agreed-upon price (the strike price) within a certain period of time. The buyer of a call option purchases the right (but not the obligation) to buy the shares at the strike price.

The seller of a call option (also known as the writer) sells the right to the buyer for a payment known as a premium. In doing so, the seller assumes the obligation to deliver the shares at the agreed-upon price should the buyer choose to exercise her or his right.

With AGNC trading at about $20.55 per share at the time of this writing, we can buy 100 shares and simultaneously sell a March call option with a $21 strike price, which is currently trading for about $0.50 and expires on March 22.

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Since we receive $0.50 for selling the call, our net cost is lowered to $20.05 per share. To give you some wiggle room, I like this trade at a net cost of $20.20 or less.

Here's how this covered call trade could work out:

If the shares rise above the $21 strike price, the buyer will buy the shares from us at $21, giving us a gain of at least $0.80 per share, or 4% in 58 days. This works out to an annual rate of return of 25%.

If AGNC trades lower, we would not experience a loss unless it falls below our net cost of $20.20 or lower, giving us a cushion of at least 2% at current levels.

If AGNC is below $21 on the third Friday of March, then the call option will expire worthless. We then have the ability to sell another call option against the shares to generate more income and lower our cost basis further.

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Action to Take --> The current price of the option is about 2% of the stock's price. Selling an option for that amount every two months would generate income of about 12% a year. That means you could potentially bring in enough income in a year to almost double this stock's already generous yield.

So using a covered call strategy allows you to generate income as you wait for more upside in AGNC, while protecting yourself on the downside and collecting a fat dividend.

This article was originally published at 
How to Almost Double Your Income on This 12.8% Yielder

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