Do you fondly remember your first foray into selling covered calls? I remember mine but, actually, it is not a fond memory at all. Perhaps you can relate to my story.
I followed a friend’s greedy advice by buying some insanely volatile Internet stock in 1999, just so I could have the satisfaction of selling a call one month out at $40 per contract. I thought I was a genius in capturing a $4,000 premium … never for a second believing the stock would fall 40 points by expiration.
If it hadn’t fallen 80 points, I’d still be engaging in that brilliant strategy of selling calls on volatile stocks today.
Buy-Writes Done Right
My usual strategy for selling covered calls (also known as the buy-write strategy) is to sell contracts one month out against half of my long position. That way I’m not going to have all my shares called away if the stock pops.
And because it’s a stock I want to hold, I’m perfectly happy if they don’t get called away. Usually, I choose calls that will give me a return of 2.5% or greater per month.
However, I’ve got another strategy – and some trading ideas that follow it — that I’d like to share with you today. This one is geared more toward generating modest monthly income with very little risk.
In this case, it centers around selling calls with very modest premiums against world-class stocks that are part of my core portfolio. I’m talking about “Forever Hold” stocks, or even “Forever Hold” stocks that also pay dividends.
Profit Now on Your ‘Forever Hold’ Stocks
Generally speaking, these are stalwarts that historically do not have gigantic moves up or down, except in the case of some extraordinary event. You only expect 8%-10% annual returns on these stocks anyway, so why not sell some calls against them and try to juice those returns?
If you get stopped out, you just buy back in. After all, these are literally stocks you intend to hold for decades and it’s highly unlikely you’ll miss a big move. If you do, then having repeated this strategy month after month will likely yield even more of a return that that one big move you missed.
Of course, if the stock isn’t called away, you keep that premium. My goal with this strategy is to grab a 1% to 1.25% return monthly, so I can see a 12%-15% annualized return.
Trade #1 — ConocoPhillips
We have a perfect opportunity right now in ConocoPhillips (NYSE:COP). It’s currently trading at $70.80 as of this writing. The COP Feb 72.50 Calls are selling for $1.02. That’s a 1.44% return for a month (17% annualized), plus the 2.4% return you’d see in the stock’s rise.
Called away? No big deal. You can buy back in. Or, since this is an oil producer, you can buy into ExxonMobil (NYSE:XOM) and play that one for a while.
Trade #2 – Altria Group
Altria Group (NYSE:MO) is another great example. At today’s price of $28.90, you can sell the MO Feb 29 Call for 50 cents, for a 2.07% total return (24% annualized if called away, 21% if not).
In certain months, you’d also collect the dividend if the ex-div date falls before expiration (although the premium will be lower). Called away? Buy back in, or jump into Philip Morris International (NYSE:PM).
Trade #3 – Coca-Cola
Coke is it! You can buy Coca-Cola (NYSE: KO) today at $67.35, and turn around and sell the KO Feb 67.50 Calls for $1.11, for a total potential return of 1.87% (22% annualized if called away, 20% if not).
Trade #4 – McDonald’s
Want a burger with that soda? Buy McDonald’s (NYSE:MCD) at $100.55, and sell the MCD Feb 100 Calls for $2.25.
Yes, that’s right — sell an in-the-money call.
Why not? It nets out to a 1.7% return, which is in the target range. And I think McDonald’s is overpriced here, so you’d actually like it to be called away.
Lawrence Meyers does not own securities in any company mentioned.