With the market in disarray, now is a good time to consider an action plan. And a bullet point on that plan should be trading options to make some income.
I happen to think the market is going to be mostly down in 2016, and may go even lower than where it is now. But you can still generate income during this period — or even just hedge your portfolio — using covered calls.
Covered calls involve taking a stock or ETF that you own, and selling the right to someone else to buy the stock from you at or above a given price (strike price) on or after a given day (expiration date). The idea is that you think the stock will not break above that price, thus allowing you to keep the underlying stock as well as the premium you were paid when you sold the contract.
And hey — if the stock gets called away, nothing stops you from buying it back, or even buying it at the strike price.
Covered Calls on the SPDR S&P 500 ETF Trust (SPY)
Based on current conditions, I would strongly considered selling covered calls against the broad indices.
Chances are you hold one of the ETFs in your portfolio, and chances are it is the SPDR S&P 500 ETF (SPY). Of course, this is an ETF that holds all the stocks of this index. It trades 130 million shares per day, so the odds are that most investors own it.
The SPY opened Wednesday at $185.27. As I said, I think the market is in trouble and will be going lower. So I would sell the April 15 $188 covered calls for $5.40. First of all, you collect $540 for the sale. That’s a nice return of just about 3% for SPY stock, over a holding period of about three months, giving you an annualized return of 12%.
Not bad if you agree with me that the market is going to be lower in three months than it will be today.
Covered Calls on Exxon Mobil Corporation (XOM)
I think you are also going to see struggling oil prices, and with them, you will see struggling oil stocks.
Now, I happen to think everyone should own at least one of the big oil explorer/producers, and these days I think Exxon Mobil (XOM) is a good way to go. XOM stock is about 30% off its all-time high, but I think there’s at least 15% more downside risk here.
Exxon stock will survive for a very long time, so selling covered calls against it is a pretty good idea. With XOM stock trading around $74.20, I would sell the April 15 $75 covered calls for $4.80. That’s a 6.4% return, plus you get 1% in dividend payments in February.
Covered Calls on Berkshire Hathaway Inc. (BRK.B)
I think you want to be with the big companies in this market, and so I know that Berkshire Hathaway (BRK.B) is also going to come out of this alive. However, it may decline more before it does.
BRK.B stock is actually down 17% from its all-time high, and there is room to fall — but this gives us another great opportunity to make a little quasi-dividend off of Uncle Warren since he doesn’t offer one himself.
Berkshire is sitting around $125.50. I think you can be aggressive here given how bearish the markets will probably be. Trying selling June 17 $125 covered calls for $8 — a generous payment of $800, which is a 6.3% return.
It’s a bit risky, but I just don’t like what the market is doing.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. 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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