Monday, March 22, 2021

Dividend Investing vs Options Income Strategy - 3Fs Strategy

I've been getting quite a bit of questions from some people who have been following my writing for some time and they noticed the recent strategy changes in my equity portfolio and so they wrote to me to understand the thinking behind the idea.

For those who are relatively new to my blog, my equity investing strategy for the past few years entails investing in dividend paying companies in the Singapore market (and more recently HKG market) while hoping for some sort of small growth as part of the overall capital appreciation.

I termed this as the "X+Y" strategy in my past article here or the "6+4"% strategy if you had attended my past talk during the 2018 BIGS Investing Conference.

Until today, I remain a huge believer of investing in dividend paying companies because of several fundamental factors which I will not talked about it in this article.

Like most people, my strategy evolves over time - and I am constantly opening my mind in pursuit of a better strategy that would fit my investing temperament and style better.

There is the CFD, a platform which I have been actively using for the past 4-5 years and activate whenever there is a huge market downturn and constraint for funds.

In the past year since I have also entered the US market, I have also tried out options investing and this will be the main topic which I will today compare and contrast the difference with dividend investing as both of them threw out similar characteristics in the form of cashflow.

I've been thinking for a while on how I can structure my answers logically because the strategy fits so well with my own philosophy that it feels very natural to me when implementing, yet it can be foreign to others. 

I'll try my best and hopefully it makes sense.

In this article, I'll break down the comparison between these few categories:

  • Cash Flow Frequency
  • Predictability
  • Passiveness
  • Volatility
  • Risk Management
  • Leverage
  • Total Return




1.) Cash Flow Frequency

I'll start with a really easy one.

Both strategy entails you to receiving a consistent amount of cashflow strategy depending on the companies and timeframe you choose.

For Singapore dividend paying companies, the frequency is typically quarterly or semi-annually (quite rarely but there are some who pays out annually), and this can be a huge revolving benefit amongst the retirees who are likely dependent on these income to survive.

For options, the typical amount of cashflow frequency is 30-45 days (for maximum time-decay ROI) but you can structure it to be a bit earlier/later depending on your strategy.

Many investors, including myself, love the psychological benefits of receiving dividends or income as a form of cashflow as this amount of pot can continue to grow over time should you decide to reinvest them.

Winner: Both Dividend and Options Strategy


2.) Predictability

Most dividend paying companies (especially if you analyze through the fundamentals of the company to ensure the payouts are sustainable) are relatively predictable in nature. Not only do they give out at a certain recurring period, but also the amount or payout ratio that they give out to their shareholders. The precedence over this is you have to put your invested money in solid companies with strong fundamental earnings and balance sheet.

Occasionally, you might get once in a lifetime cut in the dividend like what we experience during Covid where most companies in traditional industries are struggling but they are usually short in nature and you should get them back up for stronger companies.

One thing which I really like about option investing (in this case, selling cash secured puts and selling covered calls) is that you get to set the amount of premiums income that you are going to get at the start regardless of where the market is going. Sure, you might "make a loss" if the amount of premium doesn't offset the falling/rising market price but you are supposed to be happy with your strike price if assigned/sold regardless.

Winner: Options Strategy


3.) Passiveness

Most people who embark on a dividend investing strategy did most of their initial research at the start and bought them for the long term because it will continue to pay them dividend for as long as they continue to own the business and the business remains relevant.

There is little to no need to having frequently revisit the thesis unless there are big fundamental changes to the company itself.

For option investors, there is a need to get a little bit more involved as you would have to relook and replace at the whole option premium risk model to get your trade set-up. For those who are looking at the shorter time-frame such as 14 days, then you'd need to frequently revisit again your set-up based on market conditions.

Winner: Dividend Strategy


4.) Volatility

The Singapore market tends to be a little more protected in terms of volatility movement as compared to the other markets thus the share price doesn't move as much as the investors is going to get from the opportunity. Still, at the peak of the crisis, some positions can get really interesting from the forward yield point of view for long term investment.

However, when compared to the options market in HK and US, it pales in comparison as the implied volatility for these premiums at the peak of the crisis can go extremely high, sending the returns really good from a risk-reward view. The GME implied volatility, for instance, at the peak of the times was more than 600% back then, but have since subdued down to around 300% at the moment.

Winner: Options Strategy


5.) Risk Management

Risk management can get a little tricky with both strategies because we are talking about a permanent loss of capital from downside should things go south from here.

Unfortunately, neither dividend nor the options strategy are insulated from downside risk, as investors who engage in both strategies are susceptible to losses if they didn't put a stop loss to their position.

For options however, you are able to get much better risk calculation should you decide to engage long on a call or put but this is a different strategy than what I have which I will talk and cover another day.

Winner: Can be both if applied properly


6.) Leverage

Leverage can be applied to both investing strategies, which can have a double-edged sword that can amplify either gains or losses and significantly increase/decrease your net worth and cashflow.

Maybank margin financing, for instance, is offering 3.3% p.a interests for Grade 1 SGD securities, which include some of the listed REITS under their purview. This can significantly boost the income you received from the dividends, especially if the companies yielded higher than 3.3% dividend yield per annum (which is not very difficult to find in SGX market).

For US stocks, IBKR offers competitive rate for margin financing for as low as 0.85% if you have an AUM of above $3.5m with them, or 0.98% for AUM above $1.5m. Even if you just have $25k with them, their margin financing is still competitive at 1.55%.

Options trading has an advantage in a way such that an investor can sell a naked put and they will not have to pay interests on the margin unless he or she is assigned to the stock. Even so, there are ways to get away with the margin interest such as rolling away the dates.

Winner: Options Strategy


7.) Total Return

Total Return will include the dividends received including any potential form of capital appreciation, if there are any. This goes back to my earlier strategy of talking about the "X+Y", where X is the dividend you received, and Y is the capital growth appreciation you can get from owning the business.

Investing in dividend paying companies during the peak of the crisis has its own merits.

Take for instance, a company which I've invested in during the peak of the Covid - Lendlease REIT.

During the peak of the crisis when the government announced a circuit breaker lockdown, Lendlease REIT has fallen from the pre-Covid price of 90 cents to 46 cents. If you had bought the REIT back then, not only will you be able to get a recurring 5 cents dividends from the REIT every year, you will also enjoy capital appreciation when the share price rebounds back. Today, the REIT is trading at a price of 80 cents, giving investors both dividend as well as capital appreciation.

For option investors who are focusing on the income generating strategy, the return is capped at the premium you know you are getting right from the start. One downside of this strategy is that investors will not be able to enjoy the upside should the company compounds its growth and continue to make its high.

In this regard, the potential total return favors the dividend investing strategy.

Winner: Dividend Strategy


Final Thoughts

There are multiple ways you can use to construct your own portfolio strategy but I find these two income generating strategy to best fit my profile and risk.

I like the very fact that I am keeping the strategy relatively simple and easy to learn for any beginners and it is something which I think almost everyone can construct within their own portfolio.

Clearly, at this point, I am also still receiving income from my full-time job and we also have rental income from the property we rented out (maybe not in terms of cashflow increase but definitely equity increase). I also do occasionally receive side-gig income from my writing.

These income generating multiple ways impacted us favorably month after month and I definitely can already see the snowball compounding takes a good effect to that.

I hope these explanations are useful and for those who wanted more clarifications or exchange on the ideas,  you can drop me a comment in the link below.


Thanks for reading.

If you like our articles, you may follow our Facebook Page here.
You may also follow our newly created Instagram Page here.


3 comments:

  1. Hi there, thanks for breakdown of your thoughts!
    This is great content and it is always good to see how one's investment strategy evolves with different trading options over time.

    Would love to read more about your options trading strategies and the thinking behind them!

    Cheers,
    John

    ReplyDelete
    Replies
    1. Hi John

      Thanks, my goal is to make it relatively simple, stress-free and yields a good risk-reward so that anyone could easily implement.

      Delete
  2. can you do a deep dive into your option strag

    ReplyDelete

UA-57154194-1