To me, covered calls serve two really solid purposes when it comes to using this strategy in a long-term diversified portfolio, such as the one I’ll be building in my upcoming stock advisory newsletter, The Liberty Portfolio.
Covered calls can be used as a hedge. Let’s say the market may turn south, which it may do since it’s 20% overvalued right now; if a stock you own is going to go down with it, but you still want it as part of the portfolio you own, sell covered calls against the stock.
First, you earn a premium for selling the covered calls, which will partially offset any loss the stock might experience.
However, covered calls are also a relatively low-risk way of generating income. Yes, you risk losing upside if the stock is called away, but you can always repurchase it if you desire.
$1,000 Covered Calls: Microsoft (MSFT)
Microsoft Corporation (NASDAQ:MSFT) tricked me several years ago into believing it had nowhere to go. I stopped paying attention — always a mistake — and it has since become a far different operation than it was under Bill Gates.
Yet despite it being as solid a company as you’ll find, MSFT stock tends to be rather volatile, and that leads to generous premiums when selling covered calls. Combining a safe company with volatility is a great strategy for covered calls.
Usually, I aim to squeeze 1.5% to 2.5% out of selling covered calls, for something approaching a 30-day contract period. That means something like 24% annualized.
Microsoft stock closed Wednesday at $63.68. There are numerous many choices for both strike price and expiration, but it’s nice and simple to go for selling the 17 Feb $64 covered calls for $1.33. You earn a 2.1% return. Sell four of these for $532 total.
By the way, if it is called away, you earn 32 cents in capital gains, or another 0.5%.
$1,000 Covered Calls: Starbucks (SBUX)
In a similar vein, Starbucks Corporation (NASDAQ:SBUX) offers both safety in the underlying stock and lots of volatility that contributes to even more generous premiums. SBUX is going to enter a new phase soon, as Howard Schultz concocts a new growth trajectory. In the meantime, SBUX remains a dominant global brand with a solid balance sheet.
SBUX stock closed Wednesday at $58.70. Thanks to options now being available at 50-cent increments for so many stocks, you can sell the 17 Feb $59 covered calls for $1.15. That provides you with a 2% return, and it’s actually for a contract period of only 23 days! That offers an annualized return of 32%.
It isn’t much, by the way, but if it is called away, add 30 cents in capital gains to the trade, or 0.5%.
Sell three of these for $345, bringing you total to $877.
$1,000 Covered Calls: AT&T (T)
I’m not a fan of AT&T Inc. (NYSE:T) as far as it being a long-term growth or value stock to hold. It’s not in any kind of trouble, but I just don’t see the compelling ROI here. I do, however, understand buying it as a dividend stock, since it pays a very reliable yield now at 4.7%.
Regrettably, the ten-year chart shows T stock has literally gone nowhere, although you certainly managed some nice dividend payments during that period. So if want the proverbial “safe” income stock, T stock is a fine choice. It also happens to be a good choice for covered calls to generate income. Again, it’s a safe stock. The premiums are not that generous, but you can earn something.
It closed Wednesday at $41.39. The 17 Feb $41.50 covered calls are selling for 65 cents. Sell two of these to bring you to a total of $1,007.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.