Well, I think of large-cap blue-chip companies as those stuffed animals. They surround my portfolio so I can sleep easy at night.
They can also be really boring, though. Worse, sometimes they can also be stagnant. So I devised a method where I can generate some nice, safe income off of my positions in these nice, safe stocks using covered calls.
Big, blue-chip stocks will often move the most right before and after earnings reports, barring any other huge news coming from a company. That’s a great time to sell some covered calls, either against your entire position to benefit from the lower per-contract commission, or part of your position in case the stock gets called away. The beauty of this strategy is that it’s rare for the stock to get called away, and if it does, you can always buy it back — probably for not much more than it got called away for.
Now, one thing to be aware of if the stock gets called away is that it becomes a taxable event. If you own a stock from much lower prices at it gets called away, you might trigger a large capital gains tax situation. Of course, if you want to avoid that problem, simply buy back the option.
Let’s look at three examples of income-generating covered calls.
Coca-Cola (KO) is a great stock to own for the long haul. While concerns about sugar content will turn some off, people will be drinking something from Coke’s enormous line of beverages until the end of the world.
KO doesn’t even report earnings until next February, but it’s a rock-solid company that is very unlikely to experience some kind of catastrophic collapse, nor is it likely to rocket too far up over the next couple of months.
In this case, with the stock trading just above $40, you can sell the Jan 2014 $40 call for 77 cents. That’s a 1.9% return over eight weeks, or about 13% annualized. You also get a 0.7% dividend payment at year’s end (you still collect dividends as long as you own the underlying). Sure, Coke might end up above $40.77 by then, and then there’s nothing stopping you from buying the stock at that price. But you won’t lose anything if you do, and owning this company at that price is hardly a bad thing. After all, you own it at roughly $40 … so why would $40.77 be overpaying?
XOM reports earnings on Jan. 27; January options expiration is Jan. 22. Thus, if you sell Jan calls, you might see some run up or down right around expiration. If you’re nimble, consider selling the Jan 95 call for $2.17. That’s a 2.3% return, and you’d also collect a 0.65% dividend payment in the interim.
Walt Disney (DIS) is a bit dicier because the stock has done very well this year and jumps up from time to time. Still, it fits the criteria.
With DIS stock at $69, you can sell the Jan 70 call for $1.27. In this case, you’re getting more than 3% on the premium plus Disney’s 0.275% dividend at year’s end. There’s a bit more risk of the stock getting called away here, but it’s worth it, in my opinion.
As of this writing, Lawrence Meyers was long BRK.B and DIS. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets at @ichabodscranium.