If the market has you scratching your head at the moment, you’re not alone. For over three months, the market has struggled to find any direction at all. Up one day, down the next. This week, the market gave up any gains generated since the start of the year.
It’s the sort of market that can bury a short-term trader. Just as they get set in a position, the share price reverses and throws them out of the trade. While individual losses might be small, they soon add up to something larger.
Repeat this process over many months and you’ll burn up a lot of capital. It’s not just money; there’s an emotional toll as well.
It’s not as if there hasn’t been good news. This month, market behemoth Commonwealth Bank of Australia [ASX:CBA] announced profits that fell just shy of $10 billion — its best result ever.
And that was followed up by BHP Billiton Ltd [ASX:BHP] swinging back into profit — a move that enabled it to triple the dividend they paid just a year ago.
However, the reporting season showed just how scatty the market can be. Both Crown Resorts Ltd [ASX:CWN] and Woolworths Limited [ASX:WOW] initially jumped on their profit results. But within hours, the share price was heading the other way.
For a short-term trader hoping to generate capital gains, there’s a good chance they’ll have little to show for the year. However, while they might not have seen much in the way of capital gains, income investors have been able to pick up a ready supply of dividends.
A runaway bull market usually benefits both types of investors. But making money when the market is going sideways (or down), as it is now, can be much trickier.
A double shot of income
Australian investors are well aware of the dividends paid by some of our largest companies. Overall, the market trades on a yield of around 4.1%. Add in franking credits, and these dividends can help investors supplement their income.
However, while investors are familiar with collecting dividends, there are other ways to generate extra income.
Trading for capital gains is one way to generate extra income. However, it can be hit and miss, as traders have found out this year. Plus there’s tax to consider, depending on how long you hold the shares.
Another strategy is to write call options over existing shares.
Some investors shudder at the thought of options. They see options as risky, shrouded in a world of mindboggling jargon.
But writing options is a strategy used by some of the largest fund managers, including Australia’s largest (and oldest) listed investment company (LIC), Australian Foundation Investment Co [ASX:AFI].
It’s something you can also do. And the good news is that you don’t even need to set up an options account.
An ever-growing market
With a massive $2.3 trillion invested in superannuation in Australia, there is a constant supply of new products coming to market. There are now over 200 exchange traded funds (ETFs) and LICs listed on the ASX.
Some of these are strictly vanilla, like index-replicating ETFs. Others offer investors something they might struggle to implement themselves. Like investing in emerging markets, for example. Or using an option-writing strategy to generate income.
I keep a close watch on these income-based ETFs and LICs at Total Income. If you’d like to learn more about them, you can do so by clicking here.
One of the income-focused ETFs currently on the Total Income buy-list is the Equity Yield Maximiser Fund [ASX:YMAX]. YMAX trades on the ASX at around $8.90. Having generated 77.85 cents in dividends over the last 12 months, it trades on a yield of 8.7%, partially franked.
YMAX uses a two-pronged strategy. First, it owns shares in companies included in the ASX 20. These are companies that pay regular dividends to their shareholders. The second part of the strategy involves writing call options.
If you’re new to options, a call option enables the buyer to lock in a purchase price of a share in the future. In doing so, they pay the option seller (writer) a fee.
However, options are a wasting asset. Because they have a finite life, their time value erodes every day.
The aim of writing these call options is to capture this time-decay. If an option reaches expiry without being exercised, it ceases to have any value. And the option writer keeps the option fee — also called a premium.
And this is what YMAX does. It collects two lots of income streams. First, dividend income. And second, premium from writing call options.
If the market rallies strongly, this option-writing strategy can be a bit of a handbrake. YMAX might have to buy the call options back to avoid being exercised.
But it’s when the market does everything else that YMAX comes into its own. Like what the market has been doing this year. By generating two income streams, YMAX can potentially double the yield compared to holding the shares and only collecting dividends.
Editor, Total Income