by Lawrence Meyers | February 6, 2014 8:50 am
Oh, covered calls! How I love you so!
These nifty little option trades generate income for me when stocks I own are stagnant, and that always has been the primary reason I love covered calls. If some blue-chip stock is just sitting around, I can sell covered calls against all or part of my position and earn some income.
The thing about blue chips is they don’t often move very much or very quickly, except around earnings. So, I like to balance that out by selling against a position in a small-cap or midcap growth stock. These tend to be more volatile and offer greater premiums. I might miss out on some upside, but volatile growth stocks tend to gyrate enough that I can buy back in around the same price the stock got called away at.
International Business Machines (IBM) is a good blue-chip selection for covered calls. IBM has already reported earnings, and they weren’t that great. IBM stock fell as a result, so that means you could buy it here and sell a call, or if you own the stock, sell the call against your position. Either way, IBM stock is likely dead money until the next earnings report in April.
As of this writing, IBM stock trades around $174. There’s a nice play by selling the March 7 $172.50 call for $3.95. Backing out the $1.50 between the current price and strike price, that’s a 1.4%-plus return for a four-week holding period, or 17% annualized. Does anybody else think IBM stock will return 17% over the next year? I don’t.
I really like playing the covered calls game with Expedia (EXPE). EXPE can be very volatile, and that means big premiums. You have a tiny window with Expedia reporting earnings this evening. EXPE currently sells around $64, and though there’s an expiration date the very next day, you still can sell that Feb 7 $64 call for a whopping $3.80. That’s a 6% return in one day.
If EXPE gets hit, you still own it at an effective buy price of $60.20 — a good price in my eyes. If you miss the earnings report, or want to wait, then see where the stock settles. At that price, I’d sell the March expiration call. You should get about 3%-3.5% on the trade, which is a great annualized yield. I would not sell for less than 3%.
Facebook (FB) already reported last week. FB stock currently trades just over $62, and as a momentum stock, it can be quite volatile. However, Facebook seems to be hitting its stride in terms of revenue and earnings, and I think the path of least resistance is up.
Using covered calls is a great way to invest in a volatile growth stock, as it allows you to buy the stock, strip out a little gain over a month or two, and if the stock gets called away, repeat the process. You aren’t holding the stock perpetually in that instance. If FB stock gets called away and it happens to have skyrocketed, you can wait for a pullback before risking more capital.
Right now, I’d sell the March 22 $62.50 call for $3.55. That’s a solid return of almost 6%, or about a 52% annualized return.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. 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 @ichabodscranium.
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