Retired or fixed-income-minded investors often dismiss options out of hand. But even though they may seem exotic, the truth is that covered calls can offer you extra income without much more risk than merely holding a stock.
Since many retired investors already own famous a blue-chip stock (or 10), options permit you to generate a bit more cash off of them in exchange for selling earlier than you might otherwise.
Covered calls involve selling the right for another investor to buy that stock from you at a given price (strike price), on or before a given day (expiration date).
You sell covered calls if you believe the stock will not trade above the strike price before expiration. If it doesn’t close higher than the strike price before or on expiration, you get to keep the cash you were paid for selling the contract … and you get to keep the stock. However, should the stock close above the strike price on expiration, you must sell it at the strike price (but you still get to keep the premium).
Here are three covered calls on some very safe blue-chip stocks using this strategy.
Blue-Chip Covered Calls: Berkshire Hathaway (BRK.B)
Berkshire Hathaway Inc. (NYSE:BRK.B) is a great stock for covered calls because while premiums aren’t terribly high, should your stock not be called away, you can consider the premium you received as a dividend — something Uncle Warren doesn’t pay!
This strategy can result in “dividend” returns of more than 10% annually!
Just remember, should BRK.B get called away, you can always repurchase it and even sell another set of covered calls. This strategy helps create that additional income, in exchange for possibly missing out on some upward movement in the stock. (It just depends on how frequently the stock gets called away.)
The Trade: BRK.B trades at $170.25 as I write. Sell the 28 Jul $170 covered calls for $2.60. This will earn a 1.55% return in premium alone for the 29-day holding period, or 18.4% annualized.
Blue-Chip Covered Calls: Boeing (BA)
Boeing Co (NYSE:BA) is a very effective stock for selling covered calls. In my experience, since Boeing is part of an oligopoly — that is, it’s part of a very select group of companies that actually makes the plane — it has a better-than-average chance of rising in price over time.
Should you sell covered calls on BA stock and it gets called away, nothing stops you from repurchasing shares and holding it for the long-term. If Boeing falls, think of it as getting shares at an even better price.
This is the critical element of using blue-chip stocks for covered calls — if the stock rises or falls, you don’t really care because you want to own it for the long-term.
Boeing is not a terribly volatile stock, so the covered calls premiums aren’t very large. But you aren’t going for blockbuster returns here. You want slow and steady.
The Trade: BA stock trades at $199 as I write. The 28 Jul $200 calls are selling for $4.20. Sell them covered for a 2.1% return in 29 days, or about 24.5% annualized.
Blue-Chip Covered Calls: McDonald’s (MCD)
McDonald’s Corporation (NYSE:MCD) has shown great numbers since its turnaround caught hold. It’s nothing short of a classic example of how bringing in someone with vision can do wonders for a company stuck in the mud. MCD stock is truly making waves, and you can sell covered calls against it for some additional income.
Although McDonald’s has risen quite a bit over the past year, should it fall again after you sell the covered calls, you are in the same position as you were before. You are still long. If it gets called away, you can buy back into the stock. For now, it seems to me that MCD is a great candidate for covered calls, as you’re not risking missing out on too much more upside.
The Trade: MCD stock trades right now at $153.66. You can sell the 28 Jul $155 covered calls for $2.30. That gives you a 1.5% premium that you keep regardless, which is 18% annualized.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he does not own any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
