With the markets in turmoil — and if you think this week’s rally means they’re still not in turmoil, you’ve got another thing coming — it’s time to consider a few things.
Namely, it’s time to think about hedges, income generation and evaluating a portfolio’s stance — and you can address all of that by using covered calls.
Covered calls can be a good way to achieve all of these goals, particularly if you think that the rally is about to exhaust and you can make some money selling covered calls as the market declines.
Covered calls are option trades where you sell the right for someone else to buy the underlying stock from you at a given price (strike price) on or before the expiration date. The idea behind covered calls is that you believe you can sell the contract, collect the premium for doing so, and that the stock will be at or below the strike price come expiration. Thus, you keep the premium and stock.
Using covered calls on ETFs and indices in this environment can be a great idea. Here are three trades I like right now that focus on large-cap stocks, small-cap stocks and gold.
Covered Calls on the SPDR S&P 500 ETF Trust (SPY)
If you are looking to just hedge your portfolio and earn a little bit of money, there’s a fairly conservative covered calls trade you can do. Many investors probably own the SPDR S&P 500 ETF Trust (SPY), or one of the two other S&P 500 trackers — Vanguard 500 Index Fund (VOO) and iShares S&P 500 Index (ETF) (IVV).
I think this week’s rally is looking overbought, so selling covered calls against the S&P 500 can bring in a little cash to offset any possible decline.
The SPY closed Wednesday at $192.88. You have many expiration dates to choose from. The March 18 $193 covered calls are selling for $4.19. That’s a 2.2% return for a holding period of 30 days, or about 26% annualized. That’s a very generous return and worth considering.
You can also sell the March 4 $193 covered calls for $3.05. The shorter time frame means there’s less chance of the SPY being called away from you.
Covered Calls on the iShares Russell 2000 Index (ETF) (IWM)
For those looking for something a tad more aggressive, look at selling covered calls against the iShares Russell 2000 Index ETF (IWM). Because IWM encompasses a lot of smaller stocks, it tends to be a hair more volatile than the SPY, which means the premiums are bit more generous.
The IWM closed Wednesday at $100.43. The March 18 $101 covered calls are selling for $2.65. First, you get a 2.6% return, or about 31% annualized, so that’s a hefty pick-up. If the IWM gets called away, you would enhance that return by 0.57% because of the capital gain you’d pick up along the way, for a total return of 3.17%.
Again, if you want to sell the March 4 $101 covered calls, you can do so for about $1.86. In this case, the return falls to 1.86%. That’s not bad, but it also doesn’t provide as much of a hedge.
Covered Calls on the SPDR Gold Trust (ETF) (GLD)
For the truly aggressive trader, consider selling covered calls against gold. The yellow metal has been on a tear. It has backed off to the $1,200 breakout point. If the market has exhausted its buying power, and starts to fall, gold could rise again.
Because I’m not a fan of holding gold, but just grabbing singles and doubles from trading it, you could consider buying the SPDR Gold Trust (ETF) (GLD) and selling covered calls against it. It closed Wednesday at $115.48.
I prefer the near-term options here, so I would consider selling the March 4 $115.50 covered calls for $2.20. That’s a 2% return for just 15 days, or 48% annualized, which is obviously pretty significant. I would not advise selling covered calls much further out than that, but the March 18 $116 covered calls can be sold for $2.80.
I don’t see the additional premium as being worth the risk holding over the additional time period, but it’s an option.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
