If you are seeking a way to grab some substantial cash for your account, and can have some patience, while holding onto some blue-chip stocks, then you may want to give this covered calls strategy a shot. It’s one of several option strategies I use in my stock advisory newsletter, The Liberty Portfolio, to enhance income.
Here’s how it works. Either you buy, or already own, a stock that most would consider a “blue-chip.” By that, I mean a company that has a long track record of success yet is still growing earnings at least 9% annually.
They aren’t barn burners. They are steady and reliable companies. With covered calls, you may trade out some upside to generate cash today.
When you sell covered calls, you sell the right for another investor to buy a stock from you at a given price on or before a certain date. If the price of the stock exceeds the strike price of the contract you sold, the stock is “called away” from you. You can always buy it back, or even buy more at the price the stock will be called away at, if you think it will keep going higher.
Of course, should the stock not exceed that strike price for very long before the expiration date, and not close above it, you keep both the stock and premium you received.
Blue-Chip Covered Calls: 3M (MMM)
3M Co (NYSE:MMM) has proven to be a terrific long-term core portfolio holding for diversified investors. With a price tag of around $235 per share, MMM stock has returned more than 30% annually. As a diversified conglomerate playing in many sectors, it has managed growth in net income and cash flow in ways other conglomerates have not.
The covered calls I’m suggesting today are to be sold several months out, so that we can sell the calls at higher strike prices, meaning you may enjoy capital gains and premiums without the stock potentially being called away.
MMM stock just reported earnings, so you can sell the covered calls all the way into January. I would suggest the 19 Jan $240 covered calls, which sell for $3.65 per contract. So if called away, you make $365 plus $232 per hundred shares — the difference between the strike price and today’s price. That would be a return of $587, or 2.4% for a three-month holding period.
Blue-Chip Covered Calls: Alaska Air (ALK)
Alaska Air Group (NYSE:ALK) just reported earnings and they disappointed the street. I consider that to be great news, because ALK stock fell about $10.50 to $68.92. That means you can buy it cheaper, turn around and sell covered calls, and either pocket the premium and any capital gain you might get, or have purchased ALK at a 15% discount to where it just was and earn some money selling the covered calls.
ALK is my new favorite play in the blue-chips covered calls area. Alaska survived the terror attacks of 2001, the oil price spikes in 2008 and the housing crisis. It’s a resilient company. While the Virgin America purchase seems to be giving it indigestion, I believe in ALK long term.
If you buy at $68.92, and sell the 19 Jan $70 covered calls for $3.30, you’ll pick up $330 per contract right there. If called away, you’ll pick up another $108 per hundred shares, for a total of $438. That’s a 6.35% return for a three-month holding period.
Blue-Chip Covered Calls: Exxon (XOM)
Finally, although it hasn’t totally recovered from the oil crash shock, the great Exxon Mobil Corporation (NYSE:XOM) remains one of the premier energy stock plays, and perhaps one of the premier stock plays, period. The stock is still 20% off its all-time high, yet never really crashed badly. It is going to be around for a very long time, features exceptional financial stability and has many opportunities ahead of it, especially if the Russian joint venture involving Rosneft comes to fruition.
XOM stock is not very volatile, and it reports earnings on Friday, so we can sell covered calls into January and the stock will be far past any influence its latest report may have.
Exxon trades at $83.17. I suggest that you go ahead and sell the 19 Jan $85 covered calls for $1.03. The covered calls itself don’t yield a lot, but if called away, the $103 in premium will be joined by $183 in capital gains, for a total of $286, or a 3.44% return.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own 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 [email protected].