I get a lot of mail regarding a strategy I’ve outlined before, in which you sell covered calls against stocks I consider to be “forever hold” stocks. These are stocks I believe are intrinsic to both the American and the global human experience, representing companies that are global leaders in businesses that human beings simply cannot live without. They’ll be around for the next hundred years, which makes me comfortable not only holding, but passing onto my heirs.
The theory here is that if I’m willing to hold these stocks forever anyway, selling calls against them is going to provide me additional upside. I might miss out on large moves … but then, any large move that I might miss out on is likely to be made up for (or more) by repeatedly selling calls.
I suggest selling calls against at least half your position in case you are worried about missing on big upside moves. However, these stocks tend not to make huge moves, even after reporting earnings.
If these stocks get called away, just buy them back. And they will get called away, but let’s say they only get called back half the time — some of those times, you’ll be able to buy those shares back at a price less than you received in premium, cutting your upside loss.
Now, onto the three covered calls.
Covered Calls on Chevron (CVX)
Chevron (CVX) is a long-standing “forever hold” stock in my mind. Fossil fuels are intrinsic to human existence, and that simply won’t change.
CVX stock traditionally generates billions in free cash flow annually, it has $42 billion in cash and investments, and it is a premier name in energy.
CVX stock trades at $130.92. The July 25 $132 calls sell for $1.70. So you start by earning a 1.3% return on the call, or 15.6% annualized. If it gets called away, you pick up an additional $1.08 in capital gains, lifting your return to 2.1%, or 25% annualized. Expiration occurs before the company reports earnings, so you shouldn’t see too much volatility.
Covered Calls on AT&T (T)
AT&T (T) might seem like a bizarre choice as a “forever hold” stock because it’s growth appears limited.
However, with the recent DirecTV (DTV) purchase, it will have a new growth engine. T stock also is worth holding because I believe its 5.2% dividend is generous and sustainable. T stock is not a big mover, so you can sell calls against it and still get that dividend — if you sell a call but expiration occurs after the ex-dividend date, you still hold the stock, so you still get the dividend payment.
T stock trades at $35.26. The Aug 8 $35.50 call goes for 31 cents. This is only a 1% return, or 6% annualized. This is a very small premium, which is intentional because T stock tends to be for retirement investors.
However, when you factor in the dividend, it’s an 11.2% return. Then tack on another 24 cents in capital gains if called away, or another 0.6%, lifting the total potential annualized yield to 14.8%.
Covered Calls on Walt Disney (DIS)
Walt Disney (DIS) is a recent addition to my “forever hold” category. DIS stock really is the entertainment play for the next hundred years, and it will be driven by its purchases of Pixar, Marvel and Lucasfilm. It is so well-diversified, it makes so much darn money, has amazing cash flow and tons of cash on hand …Disney can’t be beat.
DIS stock trades at $84.45. The July 25 $85 calls sell for $1.09, which is a 1.3% return or 15.6% annualized. Including the appreciation, you’re looking at 1.9% returns, or 23% annualized.
Because DIS stock can experience large moves, I would only sell calls against half the position.
As of this writing, Lawrence Meyers was long DIS and DTV. 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.