Market Beat: Covered calls another option income strategies
The covered call is an option strategy that can produce extra income and help manage downside risk to some extent.
The process consists of selling call options against existing stock holdings in exchange for cash known as the premium.
For example, on Apple stock as of May 21, Apple closed at $187.63, the November 210 calls could have been sold for $3.50 each. For a 700-share position that would be a total of $2,450 minus commissions. The option expires in 179 days and the 210 call allows for an upside move of more than 10 percent in about six months. If Apple were to stay flat for the next six months and not change at all in price you’d receive a return of about 1.86 percent from the call premium and still collect the dividend which is 1.57 percent annually.
The disadvantage to selling calls is that you are limiting your upside gain to the price of 210 + the premium of $3.50 or $213.50, above that price you won’t participate in an upside move and the call will need to be bought back and rolled out to a further expiration date.
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Credit spreads known as bear call spreads can also be used to receive some income but be able to participate in a large upside move in the stock. In the case above you’d sell the 210 call and buy the 220 for a credit of $1.65 or $1,155 for a 700-share position. In that case if Apple were to make a big upside move in the next six months greater than 10 percent, you’d still participate above the 220-price level and collect some income in the event the stock is flat or declines.
Puts can also be sold if you don’t want to limit the upside and are very bullish on the stock. For example, Apple 160 puts with the same expiration can be sold for $2.45 each and will expire worthless if Apple stays above the $160 per share price.
Options can be used in various combinations depending on your outlook for the stock. If you’re concerned about a downside move in the stock, puts can be bought for protection. An investor can sell call options and use the money received to buy put options for protection in a strategy known as the collar.
All option strategies have advantages and disadvantages but can be very useful if extra income or some downside risk management is desired.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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