By Justin Shure, CFP
In our previous article we discussed the basics of covered calls. Now that we understand how they work, let us use a real-world example to generate income.
Let’s say you own 100 shares of one of the most widely held companies, Apple (AAPL). Apple trades at a price of about $127. Apple pays a dividend of .70%. Apple hit an all-time high of $145 in January of this year and has not exceeded that price since then. Stocks that trade in a sideways range can be great stocks for a covered call writing strategy.
As mentioned in the first part of this series, time plays a critical role in determining the premium in an options contract. If you are looking to sell a call, try to allow for a 7-10% upside, if possible. In this Apple example, look for strike prices that are $135 or higher. This way if your stock gets called away, you lock in a total return of 7-10% appreciation plus the premium received. Remember, to be comfortable with this strategy you need to be ok selling your stock at the agreed upon strike price. You can give yourself a higher premium and more potential upside by selling a call option with more time. A good target would be 2-3 months out.
Here are a few recent strike prices that are offering a reasonable premium, while still allowing for some price appreciation.
August 20, 2021, $135, Call is $2.67
This yields about 2.1% for roughly 2 months’ time ($2.70/$127 current stock price).
The annualized yield would be about 12.6% (if done 6 times per year)
September 17, 2021, $140, Call is $2.40
This yields about 1.9% for about 3 months’ time ($2.38/$127 current stock price).
Annualized would be almost 7.5%. (if done 4 times per year)
Both strike prices still allow for Apple to appreciate 7% and 11%, respectively.
The September contract has a lower yield since the strike price is higher, which allows for more capital appreciation.
Keep in mind, stock prices and premium prices are constantly changing. There is no science to selecting the best strike price and expiration date. If you are new to options, try to work with someone that has the experience to assist.
Since you can potentially sell your shares, you must keep in mind that capital gains taxes might be an issue. The premiums received are also taxable. For these reasons, it might make more sense to utilize this strategy in a tax deferred account, such as a traditional or Roth IRA.
A covered call writing strategy can offer a great way to enhance income in an equity portfolio where you own at least 100 shares of stock. Some stocks will give you more premium than others. If you understand that you will potentially cap your gains in return for the premium received, then this can be a great way to generate cash flow.
About the author: Justin Shure, CFP®
Justin Shure, MSF, CFP® is the founder and wealth advisor at Endeavor Strategic Wealth, LLC in Aventura, FL. He has an extensive background in comprehensive wealth management with particular depth in portfolio management. As a fiduciary, Justin provides unbiased, fee-only advice to individuals, families, and business owners. Investment advisory services offered through Bay Colony Advisors.
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