Covered Calls: Generate $1,000 in Income With These 3 Trades

by Lawrence Meyers | April 10, 2014 10:23 am

This week, I have a hankerin’ for some covered calls that will generate a cool thousand bucks of income.

Source: Flickr[1]

Of course, I always have this hankerin’.

One thing I like to do is offer investors and traders a few plays each week that in total would bring them about $1,000 in monthly income. Not to do the math for you, but if you play that out, just trading one set of these would theoretically bring you $12,000 in annual income.

For this week’s set of options trades — we’ll use covered calls, as I said — I’m going to look at two really big companies you all have certainly heard of, as well as one name that’s only familiar to those who read my column.

Compare Brokers[2]

Covered Calls: Portfolio Recovery Associates (PRAA)

covered-calls-PRAA[3]We’ll start with the smaller one that I’m very familiar with — Portfolio Recovery Associates (PRAA[4]).

I love PRAA for many reasons. The business — it’s a debt collection company that is one of the big players in a sector where compliance and regulation are forcing smaller players to get acquired or get out — is attractive.

Portfolio Recovery Associates has great growth prospects, keeps delivering on earnings, gets terrific returns out of its portfolio of debt purchasers, and is expanding also through acquisition.

It also is in that sweet spot of the $40-$60 stock price range, and is a small-cap, that generates great options premiums.

PRAA stock trades for around $58.60. The May 60 call trades at about $1.80. To be conservative, I’ll only include the premium toward the $1,000 goal (which you’d get if the stock essentially trades flat), but I’ll definitely be happy with any additional capital gains.

Selling three of these covered calls generates $540 in income, or just about 3% for a holding period of five weeks, so that’s a little over 30% annualized (If the stock does get called away, tack on another $1.40 per share, or $420).

Compare Brokers[2]

Covered Calls: Home Depot (HD)

covered-calls-hd-stock[5]One of the reasons I like Home Depot (HD[6]) for covered calls is that it’s one of these companies that isn’t going to vanish overnight.

I like using covered calls for global, large-cap brands because the risk associated with owning the stock goes down. In the worst-case scenario, if I buy HD stock and it subsequently blows up, I might be bummed in the short term … but over the long term, I know I will make my money back.

HD stock right now trades at $77.80. The weekly May $78 call (May 23) goes for $1.93. That’s a 2.5% return for six weeks, or about a 22% annualized return. Sell two of these covered calls for $386, bringing your total premiums to $926.

Here also, if HD stock gets called away, you pick up an extra $40.

Compare Brokers[2]

Covered Calls: AutoNation (AN)

covered-calls-autonation-an-stockWe just need a little bit more to push over the top. I’m looking at AutoNation (AN[7]), and that’s because the auto business continues to do well in this economy.

I also spoke to friends over the weekend who sell advertising in both radio and TV, and they say auto ad sales are doing just fine, which is another important indicator.

AutoNation happens to have a solid balance sheet and trades at 18 times earnings, which is just shy of analysts’ long-term estimates for earnings growth of 17% So buy 100 shares of AN stock at $54.42 and sell one May 55 call contract for $1.35.

At $135, that puts our total premiums from covered calls above the grand mark at $1,061.

As of this writing, Lawrence Meyers[8] did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc.[9], which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books[10] and blogs about public policy, journalistic integrity, popular culture, and world affairs[11]. Contact him at [12]and follow his tweets @ichabodscranium.

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