Covered Calls the Fund Way

Look to the pros for help with writing covered call options -- try investing in covered call funds.
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If you've been in the investing world for a while, you've probably heard about -- and dabbled with -- writing covered call options on stocks.

When you write a covered call against a stock you own, you sell the right to purchase your shares for a specified strike price at or before a specified future date. You collect a premium -- the price of the option -- for giving up this right.

And why? The main reason is to generate some current income. Those returns can be juicy -- 2% to 3% per month or more when things work out just right.

My point here isn't to give a full course on covered call writing; there are plenty of resources out there.

Instead, here's my issue. Covered call writing on individual stocks can be tricky. Getting good returns means using more volatile stocks, since option premiums are tied to volatility.

This is where a lot of investors run into trouble. Moreover, most of us just don't have the time or bandwidth, or don't want to put much risk capital into play this way. That's where covered call funds come in.

Covered call writing can be one of those areas where professional help and diversification make a lot of sense. Yet, somewhat to my surprise, only a few funds specialize in covered call strategies, and most toil in relative obscurity to the individual investor. So I want to help show the way.

Before going further, here's the main drawing card: Most of these funds pay a steady 8%-10% return, usually as a quarterly dividend. In today's environment of 4.5% money market yields and 5%-6% bond returns, that's not bad.

Most covered call funds are so-called closed-end funds, which sell a fixed number of shares that trade on an open market.

Click here for the video version of this story from Jennifer Openshaw.

For this strategy, closed-end funds work best, because the fund manager can fully deploy assets and not worry about redemptions. And investors don't have to worry about sales charges, though they might pay a small premium to the fund's net asset value.

Here's a look at some of the choices:

  • Index covered call closed-end fundsFunds sell covered calls not against stocks but against the S&P 500 index. The result is good income with downside risk matching overall market risk. The S&P 500 Covered Call Fund (BEP) - Get Report is the largest player.
  • Stock covered call closed-end fundsThese funds sell calls against individual securities owned in the portfolio. These securities can cover the market or target specific sectors, and some blend in international stocks. The portfolio percentage put into play with covered calls may vary as well. These pay somewhat more than index covered call funds. The biggest players include Madison Claymore Covered Call Fund (MCN) - Get Report, First Trust Fiduciary Asset Management Covered Call Fund (FFA) - Get Report and the ING Global Equity and Premium Opportunity Fund (IGD) - Get Report, which adds an international flavor.
  • Open-ended fundsAs ordinary mutual funds, in the face of competition, seek higher returns, covered call writing is coming back into vogue. Last summer's launch of the (VEPAX) Van Kampen Equity Premium Income Fund (VEPAX) may be one of the purer plays in this space, but the 5.75% upfront load gives me pause.

I believe closed-end funds are worth a look, especially for a portion of a well-diversified portfolio. During my research, I was particularly drawn to the Madison Claymore Covered Call Fund, which offered by far the most consumer-friendly online information and a very helpful toll-free information line.

As I investigated Madison Claymore, it dawned on me that if funds aren't quite your thing, you could even play a little "follow the leader" and mimic some of their strategies and holdings.

Madison Claymore gives an up-to-date list of its top 10 holdings. You could buy

Biogen Idec

(BIIB) - Get Report

for $49.50 and write a month-out covered $50 call for $1.65 -- an implied 4% monthly return -- or do a similar move for

Best Buy

(BBY) - Get Report



(EBAY) - Get Report

. You'd take on the risk of owning the individual stock, but at least you'd have the comfort of knowing the pros are doing something similar.

However you decide to approach it, enhancing current portfolio income with covered calls is a relatively low-risk strategy if done carefully. Covered call funds are a good way to get started.

Jennifer Openshaw, a passionate advocate for helping Americans improve their finances and build their personal fortunes, is CEO of

The Millionaire Zone and America Online's personal finance editor. In addition to appearing regularly on TV shows such as "Oprah" and "Good Morning America" and on CNN, Openshaw is host of ABC Radio's "Winning Advice" and serves as an adviser to some of America's top corporations. Her new book,

"The Millionaire Zone," will hit bookstores in April 2007.