Covered calls have always appealed to me as a way to generate income.
If you hold a long position — particularly in a stock that already pays a dividend — you can generate your own dividends by selling calls against your position. You risk the stock being called away, but if you choose your stocks carefully, they either won’t get called or they’ll get called just slightly above the strike price.
To me, that’s a win-win situation.
This week’s grouping of options trades meant to bring in at least $1,000 in income by next month includes covered calls on Amgen (NASDAQ:AMGN), JPMorgan Chase (NYSE:JPM) and the PowerShares QQQ Trust (NASDAQ:QQQ).
Covered Calls on Amgen (NASDAQ:AMGN)
Amgen (NASDAQ:AMGN) stock was moribund for many years but has returned to its old self in recent years. It finally broke to new all-time highs in summer 2012 and hasn’t looked back.
Right now, AMGN stock is at $119.30 and has been experiencing a powerful upward trend — a great time to buy covered calls. I happen to think Amgen is somewhat overvalued at 15 times earnings, so I wouldn’t buy AMGN stock with an intent to hold. Instead, I’d buy it and sell calls with the hope and expectation that the stock gets called away.
The May $120 Calls are going for $2.90. That’s right in the sweet spot of covered call returns that I like, at 2.4%. You’d also pick up an additional 70 cents per share if called away, for a total potential return of 3%. But we’re only calculating the $1,000 in income based off the premiums alone, so buy two covered calls for $580 total.
(The other great thing is that even if AMGN takes a big hit and falls, you will get your money back at some point. I choose stocks that are built to last for the long term, so even if you end up holding it, you’ll do fine in the long run.)
Covered Calls on JPMorgan Chase (NYSE:JPM)
JPMorgan Chase (NYSE:JPM) is another good play in that regard, as it remains one of the most solid financial services companies in the world. As a world-class company, it is a candidate for both regular and retirement portfolios. JPMorgan’s 2.9% yield is a nice bonus for long-term shareholders.
On the options front, JPM stock presently trades at $55.81. Were it one of these stocks that only has strike prices in $5 increments, it would likely make for a terrible trade. However, JPM stock has a $56 strike price we can play with. The May 30 $56 covered calls were recently bid at $1.11. That’s a 2% return, or 24% annualized. There’s also that 19-cent bonus if JPM stock gets called at the strike, which would bring us to 2.3% returns.
Buy two JPM covered calls for $222, bringing us to $802.
Covered Calls on the PowerShares QQQ Trust (NASDAQ:QQQ)
Another option I like comes into play when I have cash to park. I’ll buy an index ETF and sell a call against it, since I’ll need the money fairly soon. In this case, I might buy the PowerShares QQQ Trust (NASDAQ:QQQ), which is an index ETF based on the Nasdaq-100. There tends to be enough volatility in this index to give the call premiums enough value for me to swipe them.
QQQ currently trades at $87.53. The May 30 $87.50 calls are selling for $1.75 — minus the 3 cents you lose if you bought at that price, you’re looking at a roughly 2% return, or 24% annualized.
If I get stuck with the index, I’m not going to cry about it. As with AMGN, and all other stocks I choose for covered calls, if I get stuck with them, I’m happy to hold.
Buying two contracts brings you $344 ($350-$6), which brings our grand total to $1,146.
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 at @ichabodscranium.