This week, my constant quest for a stream of $1,000 in options income takes us to covered calls in a number of stocks whose businesses you’re probably familiar with — even if you don’t know it.
Picking stocks to sell covered calls against depends on your risk strategy. The more volatile a stock is, the higher the premiums will be. Two general rules for finding good candidates:
- Look for stocks in the $10 billion-$60 billion market cap range
- Look for stocks trading between $35 and $90, more or less.
The first is because midsize stocks tend to trade with some (but not great) volatility. That means you aren’t getting monster premiums, but you aren’t getting monster stock moves, either, as you might get with large-cap growth stocks like Google (GOOG). However, the stock price itself also needs to be high enough to generate decent absolute dollar premiums.
Here are the covered calls to look at for this week:
Covered Calls on Express Scripts (ESRX)
Express Scripts (ESRX) is a $59 billion pharmacy benefit management server. It handles all kinds of pharmaceutical distribution, along with all the infrastructure and support services that go along with it. In short — if you have a prescription drug plan, there’s a good chance it’s through Express Scripts.
ESRX has been on a buying binge for many years and is a market leader. It’s a great business to own, anyway, because it has so little in terms of capital expenditures, and generates more than 10 times capex in operating cash flow annually. It’s also amazingly cheap considering how expensive the market is, trading at 15 times earnings on a 15x growth rate.
You can buy ESRX here at $76.08, then sell the April 76 Call for $1.48 for a total of $1.40 ($1.48 – $.08 lost if called away) — or about 2% for a mere 23-day holding period. That’s a very attractive return of 32% annualized.
Sell three of these, and you get $444.
Covered Calls on Teva Pharmaceutical (TEVA)
Teva Pharmaceutical (TEVA) was the very first stock I purchased back in 1996, and have held it intermittently since then. It was initially a generic drug provider, and remains one of the world’s largest generic pharma companies, also the result of buying sprees. However, it develops drugs also. Copaxone was its first, which treats multiple sclerosis and accounted for 20% of company revenues in 2013. It also received a favorable Supreme Court ruling regarding its patent.
TEVA trades in-between strike prices at $53.07. One option is to sell the May 55 calls for $1.15. This provides a solid 2.05% return for a seven-week holding period if the stock isn’t called away. If it is, then you book another $1.93 in capital gains as well, bringing your total return to $3.08. That’s a 5.8% return, or 43% annualized.
Sell four contracts for $460, which brings us to $904.
Covered Calls on Waste Management (WM)
Waste Management (WM) falls into the Peter Lynch stalwart category. Its growth is a pretty consistent at 7% to 8%, and has near-legendary status for its name brand in the garbage business. It has managed to stay atop the business even as gas prices have increased, and competitors have entered the market. It increases its 3.6% dividend regularly, and pays out most of its free cash flow as that dividend. So it’s a nice hold for a retirement portfolio.
Consequently, I chose this as the most conservative option as a result.
WM stock is at $41.93. The May 42 Calls go for 80 cents, so it’s a modest 1.9% return for a seven-week holding period.
Sell two of these contracts for $160, and … well, at $1,064, it’s not a perfectly round number, but no one’s complaining.
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 email@example.com and follow his tweets @ichabodscranium.