You probably know that using covered calls is a great way to generate regular monthly income from the stocks you already own (or would like to buy). But how do you know which stocks benefit most from this strategy, and which call options to pick?
Today I want to highlight three plays that illustrate exactly how to use this strategy, because I’m using them myself on these same exact stocks.
I have four criteria for selling covered calls:
1) Use a stock I’ve tracked and want to own.
2) Sell calls against half the position.
3) Have a target return and sell in bulk.
4) Pick stocks that aren’t too volatile.
My first stock is First Cash Financial Services (NASDAQ:FCFS), a stock I’ve followed for a very long time. The company owns pawn shops both domestically and in Mexico, along with a few hundred payday loan stores located primarily in Texas.
When the stock was touching right at $40 on Thursday. I sold calls against half of my long-stock position, at the FCFS Dec 40 Call strike, for $1.85 each. My standard return target is 2.5% per month, or 3.75% for six weeks. This trade got me a 4.6% return.
Now, I’m aware that First Cash may skyrocket between now and December options expiration. But I know the stock doesn’t tend to move too much between earnings reports.
So while it is possible that I might end up having to sell half of my position (i.e., if the shares get “called away”), it won’t be the end of the world. Because I choose stocks whose trading patterns I know very well, the stocks are only called away about 20% of the time.
Next up is DIRECTV (NYSE:DTV). This is a solid company with a fantastic balance sheet. While its recent results haven’t been as great as I’d like, the company is still executing on its plan, and generating tons of cash. It’s a safe bet in my book.
On Thursday, the stock jumped up as a result of its earnings release, sending it to $47.63. I sold calls against half my position — the DTV Dec 49 Call strike for $1.15. That’s a 5.2% return over six weeks.
Again, DIRECTV could blow past $50, but its 52-week high was $53, and the results aren’t good enough to push it much beyond that. So I don’t see losing much upside here.
My final selection is actually more volatile a play than I usually choose. And yes, I said not to choose a volatile stock. But J.C. Penney (NYSE:JCP) offers a very compelling set of options.
I happen to think the company is a screaming buy, and hedge fund guru Bill Ackman has taken a sizable position in the company, and brought on Apple‘s (NASDAQ:AAPL) former head of retail store operations to run the company.
JCP has traded as high as $41 and hit as low as $23. Its volatility creates higher option premiums. So, I’ve had no problem holding a half-position and constantly selling calls.
Sometimes the stock has been called away and sometimes not. When it is called away, I just buy it again and sell calls against it again. The premiums are so lucrative that I don’t mind if the stock takes off. On Thursday, with the stock at $33.50, I sold the JCP Nov 34 Calls for $1, or a 3% return for just two weeks.
Remember, don’t just sell calls willy-nilly. You must have a disciplined plan in place, not mind losing half your position, and most of all know the stock’s trading patterns.
Lawrence Meyers owns shares of FCFS, DTV and JCP, and has sold covered calls against half his position in each.