Investors seeking additional ways to generate income should at least consider covered calls — one of my favorite strategies to use on stocks that I wouldn’t mind owning.
I say “wouldn’t mind” to encompass stocks that I would definitely own with the intent to hold for a long time, as well as stocks that I might not want to hold for a long time — but that I feel safe enough with that if I get stuck with them, I’m OK.
That’s the trick with covered calls. If you buy a stock and sell covered calls against it, but then the stock isn’t called away, you end up holding it. If the strategy works as designed, you do hold the stock, but at expiration the share price is close to the same strike price at which you originally sold the covered calls. Then you turn around and sell them again.
And lastly, if the stock gets hit for a big loss before expiration, you’re stuck holding it, but you shouldn’t mind — after all, the idea is that you’re targeting stocks you believe will eventually exceed the price you paid for it!
Here are three such stocks I think are ripe for covered calls right now:
Covered Calls on Berkshire Hathaway (BRK.A, BRK.B) Stock
Maybe you haven’t bought into Berkshire yet, but here’s a situation where you might (as long as the stock doesn’t get called away, of course).
One thing seems certain when it comes to the house that Warren Buffett built, and that’s if the stock falls apart, it’s going to get its mojo back.
BRK.B stock closed Thursday at $142.64. I would sell two Sep $145 covered calls for $2.75 each, for a total of $550. That’s only a 2% return, but you are playing with a great stock, so I don’t expect a huge premium. In fact, that’s the point: BRK.B stock is simply a safe play.
You have $2.36, or about 1.7% of buffer before the stock gets to the strike price. Otherwise, there are worse things than getting “stuck” with Berkshire Hathaway.
Total Income: $550
Covered Calls on Raytheon (RTN) Stock
Next, look at Raytheon (RTN). I like any stock in the defense sector because the U.S. is always going to need defense. And because there are only so many mega-contractors out there (and because Raytheon is one of them), RTN stock isn’t going to tank for very long if it does tank.
In this case, RTN stock closed at $101.24, and I’m going to suggest selling an in-the-money call.
If you sell two Aug $100 covered calls at $3.20, and the stock gets called away, you will net out $1.96 per contract, or $392 total. Now, that’s a pretty good thing just to start with.
However, with in-the-money covered calls, if the stock is not called away, you will get the full premium without incurring a capital loss, or $640 total. That would mean you’ll see anywhere from 1.9% to 3.2% return on this trade, or 12% to 19% annualized.
Total Income: $942 to $1190
Covered Calls on AT&T (T) Stock
I frankly don’t think much of AT&T (T), but the truth is that the company pumps out lots of cash flow, and investors are always going to provide a floor because it pays a 5.4% yield. So even though I think it’s a no-to-slow-growth company — even after it completes its DirecTV (DTV) merger — that dividend will always be attractive.
So with T stock at $35.03, you can reach into August for this trade. Sell two Aug $35 covered calls for 79 cents. If it gets called away, you net $152. If not, you get $158. Either way, that’s a 2.2% return, or about 13% annualized.
By the way, you’ll also get paid 1.35% for your quarterly dividend payment in July, so you get that bonus as well.
T stock also gives you diversification compared to the other two plays. And in the grand scheme of things, holding a telecom-satellite play, a defense play, and a conglomerate is almost like having a mini-mutual fund.
Total Income: $1,094 to $1,348
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he was long BRK.B. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
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