Options are mistakenly considered exotic securities by the average investor. Like all investments, they can be very risky, but if used properly, they can provide a steady and reliable additional source of income.
There is one basic strategy that may be of interest to the average income investor, and it’s a strategy involving covered calls. This is one of a few strategies I use in my investment advisory newsletter, The Liberty Portfolio.
With covered calls, you either own a stock or purchase it, but then you enter into a contract in which you sell the right, but not the obligation, for another investor to buy that stock from you at a given strike price on a given contract expiration day.
By selling that right, you earn money, just as you do when you sell anything.
Now, by purchasing a blue-chip stock against which you sell covered calls, you place yourself in a very advantageous position. If the stock closes at or above the strike price on the expiration date, you’re forced to sell that stock to the buyer of the contract. Obviously, then, you want to be purchasing the stock at a price equal to or below the intended strike price.
If the stock price closes below the strike price on the expiration date, you keep the stock and money you earn fbyselling the contract. However, because this is a blue-chip stock, it’s a stock you’re comfortable holding for the long term. So whether the stock gets called away or you end up holding it, you win.
Blue-Chip Covered Calls: Nike (NKE)
Nike Inc. (NYSE:NKE) offers a solid opportunity right now. The sports retail market ebbs and flows, but through it all Nike has always come out ahead. Even with some new competition on the block, Nike manages to constantly stay ahead of the competition and knows its consumers very well.
Nike stock has had a nice little rally this year and is very close to its 52 week high. It is $4.7 billion in cash, and it continues to generate exceptional cash flow generating almost $2.4 billion over the trailing 12 months.
With NKE shares closing at $66.20 on Wednesday, the 25 May $67 strike is the best obvious choice and is selling for $1.42.
That’s a generous return of 2.13% for a 38-day holding period. On an annualized basis, that comes out to about 20%. If it gets called away, you’ll You’ll also make an additional $0.80 per share, for a total return of 3.25%.
Blue-Chip Covered Calls: Yum! Brands (YUM)
Yum! Brands, Inc. (NYSE:YUM), is the holding company of those great old reliable fast foods known as Pizza Hut, Taco Bell, and KFC.
YUM restaurants not only sells food, but food that appeals to all people. Food will always sell well, because it ad will always have some core business. Because the food is cheap and at least offers some basic nutrition, and it is served quickly, it will always find customers all over the world. That’s why YUM is a blue chip stock: it is fundamental to the human lifestyle, offering products that are totally intertwined in our DNA that humans could not do without it.
YUM is a blue chip stock to sell covered calls against for investors with a long time time horizon. The stock closed at $87 on Wednesday, the 25 May $87 strike is selling for $2.15.
That’s a solid return of 2.45% for a 38-day holding period. On an annualized basis, that comes out to about 2.3%. If it gets called away, you won’t make or loss money since the strike it right at the purchase price of the stock. Not only that, YUM pays its dividend of $0.36 in early May, so you pick up an additional 0.4% just for holding the stock.
Blue-Chip Covered Calls: Starbucks (SBUX)
Starbucks Corporation (NASDAQ:SBUX) may have picked up some bad publicity lately but management is setting everything right, and the incident in Philadelphia is going to pass without any real material effect on the stock or earnings.
For everyone who complains about how bad the coffee is, and I happen to be one of them, that doesn’t stop any of us from stopping in if we need a quick fix because Starbucks is ubiquitous. It isn’t just synonymous with coffee, Starbucks shops all over the world have become central meeting places for both personal and business relationships. That’s what makes Starbucks special and successful, and always will.
SBUX stock closed at $59.50 on Wednesday, the 25 May $59.60 strike is selling for $1.56.
That’s a return of 2.6% for a 38-day holding period. On an annualized basis, that comes out to about 2.5%. Not only that, SBUX pays its dividend of $0.30 in early May, so you pick up an additional 0.5% just for holding the stock.
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.