I regard covered calls as fulfilling two separate purposes, sometimes simultaneously.
The first use of covered calls is as a hedge. If you think a stock may be headed lower, yet it’s a stock that you would like to retain in your portfolio, you can sell covered calls against it.
You’ll get paid for selling the covered calls, and that will partially offset any loss the stock may have during the term of the contract.
Alternatively, covered calls can be used to generate income. Although you risk giving up some upside to the stock if it rises above the strike price and is called away, you can put real cash in your pocket by selling these contracts.
You can target a certain amount each month if you choose, to help augment your income from month to month. I like $1,000 as a nice round number.
$1,000 Covered Calls: Microsoft Corporation (MSFT)
Microsoft Corporation (MSFT) has proven to be a fine stock over the years, even as it evolves into a new company from the one it was 20 years ago.
MSFT stock also has the advantage of retaining a decent level of volatility and safety, which makes it an ideal go-to candidate for covered calls.
Safety, by the way, is a key element to this strategy. I like to use stocks that aren’t at risk of going under. Covered calls can work quite nicely if they have just enough volatility to get a 1.5% to 2.5% return over a 30-day period or so.
Microsoft stock closed Wednesday at $52.85. You have many choices as far as which covered calls to sell. However, I think selling the July 8 $53 covered calls for $1.15 is the way to go. You earn a 2.2% return. Sell four of these for $460 total.
$1,000 Covered Calls: Nike Inc (NKE)
Nike Inc (NKE) offers a solid opportunity right now.
The market is a little annoyed with NKE stock, and that has caused it to experience a little more volatility that usual. We love volatility since that causes premiums to deliver higher returns.
It’s a good time to buy into Nike stock given the 23% selloff since its 52-week high. NKE is suffering the “sports retail contagion” right now. It’s dealing with a double-edged sword of the Sports Authority collapse and Under Armour Inc (UA) warning, while at the same time having to deal with the latter’s increase in R&D spending.
NKE stock closed at $54.77 on Wednesday, which makes the $55 strike the most natural choice here. The July 15 $55 covered calls are selling for about $1.85.
That’s a very generous return of 3.4% for a 45-day holding period. If you sell two of these, you’ll collect $370, and now be at a total of $830.
$1,000 Covered Calls: AT&T Inc. (T)
I’m not one to suggest investing in AT&T Inc. (T) if you want blockbuster returns. However, the fact is that T stock is probably the go-to safety stock for income investors.
It’s right about at its 52-week high, closing Wednesday at $38.73. As the granddaddy of dividend stocks, it pays a 4.9% yield.
It is easily able to pay this dividend with its mammoth free cash flow, cobbled together from both its operations and that of DirecTV, which it now owns.
Holding T stock, then, not only gets you that dividend, but also a very modest premium that can be collected selling covered calls.
The July 8 $39 covered calls are selling for 57 cents. That’s not much, but right at the 1.5% threshold I consider reasonable. Then, if you sell three of these, you’ll have just hit $1,001 in covered calls.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
