Blue chips are a double-edged sword. They are essential parts of any diversified long-term portfolio and even more important for the retired investor. That’s because blue chips are the safest plays you are likely to find in the market, and frequently pay reliable dividends.
The problem is that, while blue chips increase over time, they tend to move very slowly, and only in a few situations — as earnings are approaching, after they’re reported, amid big sector-specific news, or if the market moves a lot in one direction or another.
That’s why, for these blue chips that most investors tend to buy and hold, you can make a little extra money from them by selling covered calls against some or all of your position.
Covered Calls on International Business Machines (IBM)
International Business Machines (IBM) continues to defy my expectations. I consider it to be a relatively moribund business, but the market just keeps sending it higher despite weak EPS growth (and what little growth IBM does have is goosed by share buybacks).
Still, that puts IBM among the list of blue chips that are perfect for covered calls.
You can go several ways with covered calls because the options offer tons of strike prices and many expiration dates. IBM stock finished Monday at $189.65, so I would consider selling the Oct. 31 $190 covered calls for $3.95. That’s a 2.08% return for a 30-day holding period, or about 25% annualized. The 35 cents in capital gains boosts that to 2.27%, or about 27%.
Considering IBM is unlikely to return that much on an annualized basis, I think that’s a great return.
As with all covered calls, of course, if the stock gets called away, you can just buy it back. In this case, you’ll not lose any upside if you purchase IBM stock at $193.95 or below.
Covered Calls on Goldman Sachs (GS)
Goldman Sachs (GS) is usually good for some substantial premiums. As the most high-profile and controversial investment bank in the country, it tends to carry more volatility than most other large blue chips in the financial services space.
The covered calls options matrix has a host of expiration dates and strike prices as well, giving you flexibility as far as how best to take advantage of the stock’s volatility.
With GS stock trading at $183.83 at Monday’s close, consider selling the Oct. 31 $185 covered call for $3.45.
Not only do you pick up the premium for a 1.88% return, but if GS stock gets called away, you add $1.17 in capital gains to the deal. That lifts your total return to 2.51%, or 30% annualized. You’ll also pick up a piece of the 1.2% annual yield if you hold GS stock past the ex-dividend date in late November.
Covered Calls on Boeing (BA)
Boeing (BA) never seems to have bad times. Aerospace is a great business, and holding BA stock is going to serve you well over time.
Still, if you want to squeeze out some extra money, sell a covered call against the stock, which closed Monday at $128.77.
The choice here is also a Halloween covered call, the Oct. 31 $129 call, selling for $2.82. That’s a 2.19% return just from the premium, but you’ll get the extra 23 cents in capital gains if BA stock is called away, for a total return of 2.4%, or 29% annualized.
BA stock also issues its dividend in early November, which in this case is 3.2% annually, or 0.8% for the quarter, which could lift your total return to 3% if the stock is not called away. With $6 billion in annual free cash flow, that dividend is rock-solid, as it only represents 25% of FCF each year, and can juice your returns up in conjunction with a covered call.
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 pdlcapital66@gmail.com and follow his tweets at @ichabodscranium.
