Fixed-income or retired investors may dismiss using options because they seem exotic. Yet they don’t have to be, and covered calls can provide you additional income without terribly much additional risk than holding a stock.
Many of you retired or income investors already own blue-chip stocks in your portfolio and collect a dividend. Covered calls allow one to generate a bit more money from them in exchange for the possibility of selling a stock while still having the option to buy it back.
Covered calls involve selling the right for another investor to buy that stock from you at a given price (strike price), on or before a given day (expiration date).
The idea is to sell covered calls if you believe the given stock will not trade above the strike price before expiration. If it doesn’t close higher than the strike price before or on expiration, you keep the cash you were paid for selling the contract and you also keep the stock.
Should the stock close above the strike price on expiration, however, you must sell it at the strike price. You still keep the money you earned for selling the option, and you can always choose to buy the stock back at any time if you wish.
Here are three covered calls on blue-chip stocks:
Covered Calls: McDonald’s (MCD)
McDonald’s Corporation (NYSE:MCD) has been on fire ever since its turnaround started delivering. A visionary CEO was plucked from European operations and rejiggered the legacy company into something new and interesting while keeping the classic concept of the company.
McDonald’s stock risen a lot ever since, and should it fall after you sell the covered calls, there’s no reason to be upset. You are holding a stock you intended to hold anyway.
If MCD stock gets called away, you can buy it back. Because the market is showing a lot of volatility, it tells me that MCD is a solid candidate for covered calls, as you are not risking the stock going much higher in the near term.
MCD stock trades right now at $156. You can sell the 25 May $157.50 covered calls for $3.20. That gives you a 2% premium that you keep regardless, which is 24% annualized.
Covered Calls: Berkshire Hathaway (BRK)
Berkshire Hathaway Inc. (NYSE:BRK.B) is a stock I like to use for covered calls because BRK stock does not pay a dividend. That annoys a lot of investors who might like to own BRK stock but don’t because of that missing dividend.
You can create a quasi-dividend by selling covered calls against BRK stock.
However, if BRK.B stock gets called away, you can always repurchase it and even sell another set of covered calls. You may or may not miss out on upward movement, depending if the stock is going to be called away and if you buy it back before it rises too much.
BRK.B trades at $196.80 as I write. Sell the 25 May $197.50 covered calls for $6.25. This will earn a 3.1% return in premium for the 30-day holding period, or 37% annualized.
Covered Calls: Boeing (BA)
Boeing Co (NYSE:BA) is another useful blue chip stock for selling covered calls. Boeing is part of an oligopoly, which means it does what very few other companies actually do – namely, make actual planes and other defense gear. Thus, it will always do good business.
So why not sell covered calls against it. If you do and BA stock gets called away, there is no reason why you can’t just repurchase the stock and hold it again.
If Boeing stock falls, you were holding it anyway because it’s a great company with great long-term potential.
Boeing is a high price stock, so what you lose in volatility you gain in that high price as far as premiums go.
BA stock trades at $343 as I write. The 25 May $345 calls are selling for $10. Selling them generates a 2.95% return or about 36% annualized.
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.