If you’ve always wondered about options and have been trying to work up the courage to give them a try, I suggest selling covered calls against blue-chip stocks.
With this strategy, you either purchase or already own a blue-chip large-cap stock. While these stocks are likely to be slow and steady growers and deliver modest returns over the long-term, you can use covered calls to juice a little more income out of them.
If you sell covered calls, you are selling the right for someone else to buy a stock from you at a given price, on or before a certain date. Should that happen, you may not like the idea that you had to sell the stock, but you were paid for the possibility, and if the payment you received is more than the difference between the strike price and the price of the stock on expiration, you come out ahead.
And you can always buy back in, which is the point of using blue-chip stocks for your covered calls. There’s not a ton of long-term danger of holding one.
Here are three trades you can make now with covered calls:
3 Blue-Chip Covered Calls: Southwest Airlines Co (LUV)
Southwest Airlines Co (NYSE:LUV) is my new favorite play in the blue-chips covered calls area. I used to stay far away from the airlines, even though Southwest was always the one airline that was extremely well-managed. I finally bought some for my 401K, and just added to it on Thursday.
Southwest has survived 9/11, high oil prices, and the financial crisis — and it will survive just about everything else. So buying here at $37.23 and selling weekly Jun 26 series $38 covered calls for $1.10 is a very generous 3% return for a covered call that is out of the money by 2%.
Thus, if your LUV stock is called away, you will earn a total of $1.87, which is a 5.02% return, or 50% annualized. That is an incredible rate of return.
If the stock isn’t called away, then you get it at an effective price of $36.23, also very attractive.
3 Blue-Chip Covered Calls: Exxon Mobil Corporation (XOM)
Despite the crash in oil prices, Exxon Mobil Corporation (NYSE:XOM) hasn’t been hit that hard. The stock is only 17% off its high despite a 40%-50% drop in oil prices. I think the worst of the oil price fall is over, and XOM has a great balance sheet and generates tons of free cash flow.
It remains a premier must-own energy stock.
However, I don’t expect the stock to move very much while oil prices remain under pressure, so it is a good time to sell covered calls against one of the premier blue-chips.
XOM trades at $87.21. It doesn’t report earnings until late July, so you can go ahead and sell the Jul $87.50 covered calls for $1.86.
So if the stock gets called away, you get that $1.86 plus another 29 cents in capital gains. That brings you to a total of $2.15, which is a 2.47% return, or about a 17% annualized return.
3 Blue-Chip Covered Calls: 3M Co (MMM)
Another perpetual winner for covered calls is 3M Co (NYSE:MMM). This conglomerate has a wide moat because it operates in so many distinctive industries. It has great cash flow and its diversification gives it many ways to play in both good and bad economies.
MMM stock also doesn’t report earnings until late July, and since you don’t want to be playing with options during earnings season, you can use the July expiration date. The stock trades at $162.06. I would sell the Jul $165 covered calls for $2.09.
Even if the stock isn’t called away, you pick up a 1.3% modest return. However, if it is called away, you pick up another $2.94, for a total of $5.03.
That gives you a total return of 3.1%, or about 31% annualized.
As of this writing, Lawrence Meyers owns shares of LUV.
