Covered calls are one of my favorite ways to generate income. I think of covered calls as a kind of “bonus” dividend, since they let me generate income from my holdings if a stock isn’t really moving.
With covered calls, you are selling the right to someone to buy the stock you hold at a given price on or before a given date. This means if the stock never rises about that price, you get to hold onto the stock.
Even better, by selling the right for someone else to buy the stock, you have collected a premium. You get to keep that premium if the stock is not “called away,” and that’s where my notion of covered calls as a bonus dividend comes from.
If the stock gets called away, you just hope the stock doesn’t end up trading at or above the price you sold it at plus the premium you received. (That doesn’t mean you’ve lost anything, just that you’ve missed out on potential upside.)
These covered calls are for the Sept. 26 options expiration date. Because earnings reports are not due during this period, it means these stocks have little news to move on — ergo, you likely will collect the premium with little risk of the stocks being called away.
Covered Calls on Home Depot (HD)
Home Depot (HD) has been in the news recently thanks to earnings that indicated life was really good for both the company and its industry. HD stock already has moved significantly higher, though, which means it likely has exhausted a lot of the market’s buying power.
That’s a good time to sell covered calls on HD stock, which presently trades at $91.87.
The Sep 26 $92 covered calls are selling for $1. That’s a 1.1% return for a four-week holding period, or just more than 14% in annualized returns. That’s a great deal on a premier blue-chip company.
If HD stock gets called away, you’d also get the 13 cents in capital gains, for a total return of 1.13% or 16% annualized.
Covered Calls on BP (BP)
You don’t hear much about BP (BP) anymore, and that’s a good thing. With the Gulf of Mexico disaster in the past, the oil company remains the most volatile of the oil explorers and subject to good premiums as a result. BP stock trades at $48.36, and it has strike prices available at 50-cent intervals.
You can sell the Sep 26 $48.50 covered calls for 62 cents. That’s a 1.28% return, or 16.6% annualized. A 14-cent capital gain, which would come along if the stock got called away, would boost the return to 1.57%, or 20% annualized.
Covered Calls on Visa (V)
The final selection is one I frequently use myself. Visa (V) is a great company, operating in an effective duopoly situation with MasterCard (MA). V stock is something you probably want in your long-term portfolio. Even though it got hit after it reported modest earnings, it has climbed back (to $217.13 presently), and that’s why I love it so.
The Sep 26 $217.50 covered calls sell for $2.60. That’s a 1.2% return, or 15.6% annualized. If called away, you pick up an additional 37 cents in capital gains for a very tidy 1.38% return, or 18% annualized.
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 firstname.lastname@example.org and follow his tweets at @ichabodscranium.