Don’t assume that if you are a retired or income or conservative investor that you don’t need to have an interest in options. Indeed, selling covered calls can generate income while providing extra padding to your wallet with little risk.
Covered calls are one of the strategies my stock advisory newsletter, The Liberty Portfolio, uses to reduce overall investment risk and generate extra income. With the best covered calls, you own a certain stock, or you buy it for the purpose of selling covered calls, and just use covered calls to make a little more money off of them in exchange for possibly selling earlier than you normally might.
With covered calls you are selling the right for someone else to buy a stock from you at a certain price (strike price), on or before a specific day (expiration date).
You do this because you believe the stock won’t trade above the strike price before expiration. If that stock does not close above that strike price before expiration for more than a couple of days, or does not close above that strike price on expiration, you both keep the money that you were paid for selling the contract, and also keep the stock.
However, if the stock closes above the strike price on expiration, you will have to sell it at the strike price but you will still keep the premium.
Here’s a way to generate income for the next month using covered calls on three blue-chip stocks.
Best Covered Calls: McDonald’s Stock
McDonald’s Corporation (NYSE:MCD) has made quite a turnaround under its new CEO. I think MCD has good times ahead of it so owning McDonald’s stock is probably not a bad move for a long-term diversified portfolio.
We’ve just been through a small market correction, and if MCD stock falls further, and you sell covered calls and the stock falls, you are likely getting it at a better price.
Even if McDonald’s stock gets called away, and you buy back in, and then it falls again, I would not panic. That just means you can buy in at a lower price and average down. MCD will do well over the long term.
MCD closed at $160 on Wednesday. You could sell the 23 March $160 covered calls for $3.55 at last check. You get a 2.22% premium and keep it if it isn’t called away.
Or you could sell the 20 April $160 covered calls for $4.75, enjoy an almost 3% return, and have a nice little bit of income to the tune of $4.75, as well as earn $1.01 from its next dividend payment.
Best Covered Calls: Berkshire Stock
Berkshire Hathaway Inc. (NYSE:BRK.B, NYSE:BRK.A) also has options available, but only for the B shares. I doubt very many people have 100 shares for a single options contract on the A shares, after all.
Berkshire stock may be the perfect stock for covered calls. The premiums aren’t gigantic, but if the stock isn’t called away, then that premium you just sold could be thought of as a dividend. Remember, Berkshire stock doesn’t pay dividends. You can even generate dividend-like returns in the high single digits each year using covered calls.
So, if BRK does get called away, buy it back and then perhaps go ahead and sell covered calls again. Over time, this strategy is going to throw off a nice little bit of income, and you may or may not miss some of the upside depending on how often the stock gets called away.
Wednesday saw BRK.B stock end at $200.53. You can sell the 23 March covered calls at the $200 strike. If you elect to sell those covered calls for $5.75, you’ll earn a 2.78% in premium.
Best Covered Calls: Boeing Stock
Boeing Co (NYSE:BA) is a strong candidate for selling covered calls. Boeing stock is a great security because not only does it deal in defense, which is always needed, but also because it is part of an oligopoly.
Thus, should you sell covered calls on BA stock and it is called away, you can buy right back into it and continue holding over time. If BA stock should fall by a substantial amount, I might think of it as another buying opportunity. That’s the idea using blue-chip stocks — you don’t mind owning it.
Boeing is not a volatile stock, so the premiums aren’t terribly large, but you are playing it safe and that’s the point.
On Wednesday, BA stock closed at $345. The 16 March $345 covered calls are selling for $11, which is a 3.2% 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 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.