I was first introduced to covered calls by a friend who had a lot of investment experience. His strategy was to find momentum stocks, buy the underlying shares and sell covered calls against those stocks for very large premiums. Back in the days of the Internet bubble, this could mean selling a covered call one month out for $2,000 or more.
The problem? If you were around then, you’d know that momentum stocks could also decline very quickly. I found myself holding stocks that, despite the premium I received, were very much in the red, and that made me nervous. So I would be forced to sell the stock at a loss, even including the big premium.
As I got more sophisticated, I realized the better way to go was to buy a solid stock that I could hold onto without being nervous, if it didn’t get called away.
For those interested in that strategy, here are some ideas on covered calls that you can trade against blue chips.
Covered Calls on MasterCard Inc (MA)
MasterCard Inc (NYSE:MA) is among the better blue chips you can use to trade covered calls. If you get stuck holding it, I’ll play you the world’s smallest violin. You should hold either this or Visa Inc. (NYSE:V) in your portfolio because they are an effective duopoly.
However, MasterCard stock has reported earnings already, so it probably will not move very much in the next few weeks. That means you should be able to squeeze out some premium value. The stock closed at $91.32 on Tuesday. The Mar 27 $91.50 covered call can be sold for $1.92. That’s a 2.1% return for a 31-day holding period, or 25.2% annualized.
I aim for about a 2% premium on blue chips for a one-month holding period, give or take a few days. Should the stock get called away, you pick up an additional 0.2% in capital appreciation.
Sell two of these for $384 in premiums.
Covered Calls on Walt Disney Co (DIS)
I personally wouldn’t sell covered calls against Walt Disney Co (NYSE:DIS) but recognize that some investors may see an opportunity for this blue chip stock. Certainly, one should not have any concerns at all about selling a covered call against DIS stock and being stuck with it if it isn’t called away.
The stock closed Tuesday at $104.67, just off its all-time high of $105.23. This could bode either direction for the stock. Maybe it busts through the high, or maybe the high becomes resistance. In either event, the Mar 27 $105 covered calls can be sold for $1.75.
In this case, you may wonder why I find the 1.74% return (21% annualized) to be acceptable. That’s because in mid-March, you should pick up a dividend payment of 28.75 cents per share, which would lift that total return to just about 2%.
Sell two of these calls for $350 in additional premiums (plus the Disney dividend), bringing you to $734.
Covered Calls on DirecTV (DTV)
It amazes me that DirecTV (NASDAQ:DTV), which AT&T Inc. (NYSE:T) is trying to purchase for $95 per share, still trades at $87.46. That’s just lunacy, because the market seems to think the merger won’t go through when it will. There’s no way it will be blocked.
But hey, that gives you a great chance to buy the stock here, and sell the Mar 20 $87.50 covered calls for 93 cents. Here you have a 24-day holding period, and a 1.06% return. That’s lower than I’d like, but the slightly shorter holding period is what makes it acceptable (it’s 16% annualized).
If you sell three of these, you’ll pick up another $279, for a grand total of $1,013, not counting the Disney dividend.
You should be prepared for DirecTV to get called away, because the announcement that the merger is approved could come at any time. However, if you get stuck with the stock, be happy. You could sell more calls against the stock, or hold until the merger is approved, and pick up another 8.6% in capital appreciation when the stock goes to $95.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He is the manager of the forthcoming Liberty Portfolio, has 20 years’ worth of experience in the stock market and has written more than 1,200 articles on investing. As of this writing, he owned shares of DIS, and had sold naked puts against DTV (April $87.50). He can be reached at TheLibertyPortfolio@gmail.com.
