Options are still considered rather exotic securities by the average investor, and in some ways, that’s a good thing. They can be exotic and there is a higher degree of risk associated with them, depending on what one’s investment goals are. I made big mistakes using options early in my investing life because I didn’t really have a clear purpose for using them.
However, there is one basic strategy that may be of interest to the average income investor, and it’s a strategy involving covered calls. This is one of a few strategies I’ll be using in my forthcoming stock advisory newsletter, The Liberty Portfolio.
With covered calls, you either own a stock or purchase it, and then sell the right, but not the obligation, for another person to buy that stock from you at a given price on a given day. It generates income for you when you sell the call.
I sometimes like to use blue-chip stocks when selling covered calls. That’s because they tend to have modest premiums, and if you don’t have the stock called away, you are still owning a quality company. If it does get called away, you can always buy it back.
Covered Calls: Microsoft (MSFT)
Microsoft Corporation (NASDAQ:MSFT) is a prime candidate for selling covered calls against blue-chip stocks. Believe it or not, MSFT is right near its all-time high and it has tons of cash.
I actually think it’s overpriced here at 30 times earnings with only 10% earnings growth, so if you own it and it gets called away, you may want to consider waiting for a price drop before buying back in.
MSFT closed Wednesday at $63.34. The 24 March $63.50 covered calls are selling for $1.10. That’s a very modest return of 1.74% for a holding period of 44 days, or about 13% annualized. It’s a bit less than I’d like to get, but reasonable.
Covered Calls: Exxon Mobil (XOM)
Oil prices seem to have stabilized but Exxon Mobil Corporation (NYSE:XOM) has fallen out of favor with investors. After doing exceptionally well compared to most blue chips in the oil patch, XOM stock has floundered a bit.
I think it’s due to concerns over big expenses coming up, but I think this is unfounded. As I’ve written, I believe the Rex Tillerson confirmation will eventually lead to the big Rosneft deal starting to produce.
There’s probably also some concern about valuation. On an EV-to-Ebitda ratio, which I think is the best way to evaluate the big producers, it’s expensive compared to almost all of its peers. Thus, I think a near-to-medium term decline seems likely, so having XOM called away is not a bad thing.
XOM closed Wednesday at $81.50. The 24 March $81.50 covered calls are selling for $1.78. That’s 2.2% returned in 44 days, or about 18% annualized.
Covered Calls: AT&T (T)
AT&T Inc. (NYSE:T) can sometimes be one of the blue-chip stocks to sell covered calls against. For starters, despite its mountain of debt, it produces amazing amounts of free cash flow.
It usually pays out about half to cover its 4.77% dividend. It recently hit a multi-year high, added DirecTV to its portfolio, and is now trying to merge with Time Warner Inc (NYSE:TWX).
The merger makes great sense, but given President Trump’s hawkishness toward media these days, some people think he might try to pressure agencies to block it. I don’t think that’ll happen, but it may put near-term pressure on the stock.
T closed Wednesday at $41.21. The 24 March $41.50 covered calls are selling for 65, cents which is a return of 1.6%. However, if called away, you pick up another 29 cents in capital gains, or 0.7%, for a total of 2.3%.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
