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Generating Extra Income In A Volatile Market

Investors who bought into the a2 Milk Company Ltd [ASX:A2M] any time over the last few years must surely be patting themselves on the back.

Ever since the NZ-listed company decided to list on the ASX, its share price has been on a tear.

On its first day of listing in March 2015, A2M traded at just 56 cents. Yesterday it was trading as high as $12.30. Only 12 months ago its share price was around $2.20.

This price action makes A2M the best performer on the ASX 300 over the last 12 months.

Investors must be hoping that it doesn’t suffer the same kind of jitters as the second best performer on the list, Bellamy’s Australia Ltd [ASX:BAL].

Remember Bellamy’s — the infant formula company that rocketed from its $1 issue price to $16 in less than 18 months?

A string of ‘missteps’, along with a trading halt, saw its share price collapse. It was back trading below $4 at the start of last year.

However, Bellamy’s has also had a cracking year. And this time with much less fanfare. Since the start of 2017 its share price has more than quadrupled.

It’s these kinds of gains that pull investors into the market. They only need to find one or two stocks like this in their lifetime to deliver game-changing wealth.

However, if it goes wrong, like Bellamy’s fall from 2016–17, investors can watch a chunk of their capital evaporate.

Dividends or share price growth?

That’s why, despite the allure of big gains, many investors hover around some of the more predictable but boring large-cap stocks.

The problem with that, though, is that some of their share prices just won’t budge. Commonwealth Bank of Australia [ASX:CBA] is the only one of the Big Four banks to be trading above its pre-GFC high.

Other top 20 stocks have suffered a similar fate. Woolworths Group Ltd [ASX:WOW] and Wesfarmers Ltd [ASX:WES] are trading around the same price they were in 2007.

Despite the lack of share price growth, investors hold on to these stocks for their steady stream of dividends. Plus the franking credits that come with them.

However, if an investor’s goal is income more so than capital growth, there is another way to hold these stocks while increasing income beyond the usual dividends.

While investors are well aware of ETFs, they might not be aware of the diversity on offer. One such ETF, BetaShares’ Equity Yield Maximiser Fund [ASX:YMAX], offers another way to generate additional income.

YMAX holds the top 20 stocks on the ASX as per their index weighting. It then collects the dividends (and any franking credits) from these holdings. All a bit ho-hum, you might say.

However, YMAX has a second strategy which makes it different. It writes call options over these same shares to generate income. By writing (selling) call options, it aims to capture something called time decay.

As options have a finite life, each day the time component of their value decreases. Once an option lapses without being exercised, it ceases to have any value.

Writing a call option locks you into handing over the shares at the option’s strike price. One of the harder things is working out at which price level to write them.

If the share price goes above this level, and the buyer exercises the option, you are giving up potential profits. In this case, to avoid being exercised, the option writer has to buy the option back. Depending on the share price, they might have to pay more for the option than they sold it for.

Because of that, writing call options can put a cap on potential profits, especially in a bull market. However, in a range-bound or slightly bearish market, options can help spruce up your income.

YMAX will generally track the performance of the top 20 stocks in the index. And that’s why its share price has barely nudged over the last couple of years.

However, add in the quarterly dividends, and the yield is currently around 8.6%.

An ETF like YMAX won’t run away to big gains. Especially not like Bellamy’s or A2M have done over the last year. However, when volatility increases and markets start to trade sideways, it can be a handy way to generate extra income.

View More Articles By The Daily Reckoning

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