The time has come for the average investor to consider using covered calls. We’ve been using them in our High Yield Trader portfolio over the past two years with great success.
After I go over the basics of a covered call strategy I want to show you exactly how we have managed to, at least, triple the dividend in each of the blue chip companies held in our High Yield Trader portfolio.
What is a covered call?
Covered calls are an options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset.
The strategy is often employed when an investor has a short-term neutral-to-bearish view on the asset. For that reason, he decides to hold the asset (long) and simultaneously have a short position via the option to generate income from the option premium. Covered calls are also known as a “buy-write” strategy.
For example, let’s say that you own shares of Apple (NASDAQ: AAPL). You like the stock’s long-term prospects, as well as its share price, but feel in the shorter term the stock will likely trade relatively flat to lower, perhaps within a few dollars of its current price of roughly $132.65. If you sell a call option on Apple at the strike price of 140 with 60 days left until expiration, you will earn a premium of $242 per options contract, but cap your upside gain at $140.
By collecting $242 per contract you will make roughly 1.8%. I know 1.8% doesn’t seem like a lot, but we need to remember that we can make a similar transaction every 60 days, or approximately six times a year, for a total of 10.8%. The 10.8% return is almost seven times the current 1.6% Apple dividend.
One of three scenarios is going to play out:
- Apple shares trade flat (below the $140 strike price)– The option will expire worthless and you keep the premium from the option. In this case, by using the covered call strategy you have successfully outperformed the stock.
- Apple shares fall– The option expires worthless, you keep the premium, and again you outperform the stock.
- Apple shares rise above the $140 strike– The option is exercised, and your upside is capped at $140, plus the option premium.
If this occurs, you will make 5.5% in capital gains plus the 1.8% in call premium.
As I have often stated, most investors think of options as high-risk, speculative strategies where large losses can be incurred. While this is certainly true of some options strategies, covered calls are actually more conservative than investing in ETFs or stocks alone.
In other words, a covered-call strategy is SAFER than buying a stock or an ETF.
Why? Because covered calls:
- Provide some protection in a down market.
- Are one of the few ways an index investor can achieve double-digit returns in a flat or slow-growth market.
- Lower your cost basis while decreasing the volatility of your portfolio.
Remember, covered calls make money when stocks are slightly higher, flat or down. You only get the underlying stock “called” away if it rises significantly.
So again, why would any investor choose to shy away from such a proven income strategy that has outperformed the market and dividend-paying stocks over the long term?
We’ve been selling covered calls and puts in the High Yield Trader on stocks like Apple, Microsoft (NASDAQ: MSFT), General Electric (NYSE: GE), Wal-Mart (NYSE: WMT) and many others for incredible returns since April 2013.
If you would like to know more about how we use our unique income strategies please make sure to join our live event on Wednesday, July 29. Ian Wyatt and I will be discussing covered calls as well as one of my other favorite income strategies, selling puts. In addition, we will be giving away four trades.
So tune in if you would like to get started on what I feel are two of the best income strategies offered to individual investors.