It’s easy to generate regular monthly income from your investments. Dividends from stocks and bond interest are the most common ways to get it. But what if the companies in your portfolio offer a paltry dividend, or none at all?
You don’t have to wait for quarterly or even yearly payouts that could end up being reduced or eliminated entirely. With options, you can turn your current stocks into a source of steady returns – even when the shares are stagnating or sliding.
Today I’m giving you four tips for successfully using the “covered call” strategy, which will help you target and collect the type of income you deserve from your stocks … on a payment schedule that works best for you!
1) Begin with a stock you’ve tracked and want to own.
Many stocks trade within a given range for a long time and, if you’ve been watching closely, you know what that range is. In my case, I’ve followed EZCorp (NASDAQ:EZPW) for many years, and believe the stock is undervalued.
I’ve purchased the stock at $29 and, for many of the past several months, have sold the 30 calls one month out, over and over again — each month yielding a 2%-3% return. If the stock gets called away, I’ll be a bit bummed, but I can always buy the option back or buy more stock. If the stock doesn’t get called away, I’ve generated some nice income.
The reason I suggest doing it with a stock you know well is because you can get bitten if you play with a stock you don’t know. I once purchased a high-flying Internet stock called ICG Group (NASDAQ:ICGE), once known as Internet Capital Group, and sold a call against it to capture a big 8% gain of about $1,000. Then the stock fell 50 points over the next few weeks, and I suffered a big loss.
2) Sell calls against only half your position.
Remember, you want to own this stock. So you don’t want it “called” away.
My expectation for covered-call candidates is that the shares will remain range-bound for a while. If the stock suddenly explodes, I’ll be a chump for having sold calls against my entire position.
3) Have a return target and sell in bulk.
How much income do you want each month? That will determine which stocks to pick. If your portfolio is gigantic, a 1% monthly return may be just fine, and that means you can sell calls against large-cap stocks like General Electric (NYSE:GE). I am more aggressive, and aim for 2.5%, which usually means targeting small-cap stocks.
Also, since options commissions are frequently charged as a flat fee plus a bit more for each contract, I like to sell in bulk. For example, I might take a 1,000-share position in a stock under $30, like J.C. Penney (NYSE:JCP), and sell five contracts to minimize my per-contract cost.
4) Pick stocks that aren’t too volatile, especially near earnings.
You must choose a stock that doesn’t have exposure to news that could totally change the company’s story. For example, the premiums on Education Management Corp. (NASDAQ:EDMC) are huge. But there is every possibility the Department of Justice’s lawsuit over its recruitment policies may bankrupt them.
Also, I don’t sell options that are set to expire during an earnings reporting period. If the company surprises, I don’t want my shares called away. You can sell calls any (and even every) month, but oftentimes it’s wise to wait until after earnings for the stock to return to stable, income-generating territory to make the trade.
Lawrence Meyers currently has sold Oct 30 calls against his EZCorp stock, and holds shares of GE.