If you think options aren’t for you, stop right there.
I didn’t think they were, either, but then I researched all the benefits and risks, and realized they were. Now, a new world is opened up to me. Yes, you need to have the appropriate risk tolerance, but the simplest trades — such as covered calls — are a great way to make income.
I like to sell covered calls because it’s a reliable strategy that can produce income — and you can do it with big, solid companies. (In other words, even conservative investors can join in.)
Selling covered calls is an options trade in which you own a certain stock, but you sell the right for somebody to purchase that stock from you at a given price (strike price), on or before a certain day (expiration date).
Why would you do this? Well, you might think the stock won’t go above the strike price by the expiration date by more than you sold the covered calls for. If the stock doesn’t move above the strike price on or before expiration, you keep the premium that you were paid, plus the stock.
The flip side, of course, is that if the stock does close above that price, you’ll have to sell shares at that price.
Here are a few covered calls I’m mulling right now:
Covered Calls on Boeing (BA)
Boeing (BA) is a great stock for covered calls because it is a company that has few competitors.
Not everyone builds airplanes.
BA stock trades at $136.05 as of Monday’s close. You could sell the Oct $135 covered calls for $3.50 per contract. With this trade, you collect $350 less commission, which is about a 2.8% return minus the $1.05 you’d lose in capital loss for selling at $135 and buying at $136.05. That’s a total return of 1.8% — very reasonable for a stock of this caliber.
If BA stock closes below $135, then you keep your premium for selling the call, and you keep the stock. You could then sell another set of covered calls for the next month.
If Boeing “flies” past $135, you’ll have missed that appreciation. But hey, you can just buy more BA stock to replace the shares that got called away.
Covered Calls on MasterCard (MA)
MasterCard (MA) is one of the best stocks to use for trading covered calls. Frankly, you probably should have MasterCard stock in your portfolio anyway, and sell covered calls against some of the position.
MasterCard a great company and part of a virtual duopoly with Visa (V). It has amazing financials, and let’s face it, MA is going to be around for a very long time. It’s a premier company with a legacy business that is continually expanding its product line.
MA stock closed at $93.13 on Monday. In this case, I actually prefer the weekly Oct. 30 $93.50 covered calls, which can be sold for $2.76. That’s a 3% return for a 40-day holding period, or 27.2% annualized.
Since I normally aim for a 2% premium for a 30-day holding period, these covered calls on MA stock offer a pro-rated return in line with my target. Should the stock get called away, you pick up an additional 50 cents, or 0.4% in capital appreciation, for a 3.4% overall return.
Covered Calls on Home Depot (HD)
It is difficult to argue against selling covered calls on the great Home Depot (HD). My thinking is that the stock is actually overvalued at its Monday closing price of $116.59. However, just because a stock is overvalued doesn’t mean the market will sell it off.
In this case, I just think HD stock has limited upside. So, rather than just sell out, why not sell covered calls on HD stock and reap some premium reward? You could run with this play for as long as possible and squeeze out a lot of money before HD stock gets called away.
The weekly Oct 23 $117 covered calls are selling for $2.55. That’s a 2.2% return for that 33-day holding period, or a 24.2% annualized return. What’s great about this is that if you sell two or three rounds of covered calls on HD stock and it doesn’t get called away, you’ll collect enough in premiums to effectively earn what you would have had Home Depot hit new all-time highs.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
