How to Sell Covered Calls to Create Portfolio Yield

OPtions terminology

It is becoming more and more apparent that the Federal Reserve is going to be patient in raising interest rates. In fact, several high profile hedge fund managers have recently said that they expect the Fed will CUT rates in 2019 or 2020. Because of this monetary policy, it’s still a challenge for savers to create yield. That said, there is an alternative way to create yield against your stock holdings: sell covered calls.

A Covered Call is an options trading strategy in which the trader holds a long position in a stock and sells a call option on the same stock in an attempt to generate income. For example, if I owned 100 shares of Workday (WDAY) I could sell one call against my 100 shares. And when I sell that call I collect a premium (essentially collecting an insurance premium).

Below is an excerpt from a Bloomberg article about selling covered calls using Goldman Sachs research. And while the research is good, after the Bloomberg article I will break down what I believe to be a better way to sell covered calls.

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How to Sell Covered Calls

“Interest in an options strategy that involves selling bullish calls while holding the underlying stock to generate income has increased substantially over the past six months as slowing economic growth shakes investors’ faith in U.S. equities, according to Goldman Sachs.

“Overwriting, as the strategy is called, has historically outperformed the buy-and-hold approach when stocks trade within narrow price ranges or decline, according to Goldman derivatives strategists including Vishal Vivek. Their research found that selling one-month, 10% out-of-the-money covered calls on S&P 500 Index stocks has led to an annual outperformance of 1.4% on average over the last 16 years.

“For example, Apple (AAPL), the S&P 500’s second-highest weighted stock with a current share price around $174, shows the March 29 $190 strike call option trading around 24 cents. If an investor was looking to implement the overwriting strategy on a rolling one-month basis, they could potentially collect $2.88 over a 12-month period, or the equivalent of 1.6%.

Want to sell covered calls on your Apple holdings? Look at this chart.“Of course, overwriting is not without its own risks. While the call options are covered by the underlying stock ownership, a rally through the strike price could translate into a sale as shares are called away, forfeiting further gains on the position.”

While I have no doubt that the research is solid, I think selling calls for $0.24, and creating a yield of 1.6% over the course of a year is largely a waste of time. So how would I implement this strategy?

WDAY Covered Calls

Below is the gist of an email exchange between a Cabot Options Trader subscriber and myself in which I show how I choose which strike to sell against my long stock holdings. I will use Workday (WDAY), which is trading at 182, as my example.

“I have a question about covered calls. How do you determine what new strike and date to sell covered calls? I’ve been doing okay with my guesses but I thought I’d find out how you decide what strike and expiration to use. Is there some general rule that you use in choosing the strike and expiration?”

My reply: “There isn’t a surefire answer for each situation. But I will show you my general thought process.

“These are the questions I ask myself in this order for choosing a strike price to sell:

“1. At what price am I willing to sell the stock? If I am willing to sell WDAY at 185, then I would sell the 185 strike. If I am willing to sell the stock at 210, then I would sell the 210 strike.

“2. If the market is stable, and trending higher, then I am more likely to sell a call further away from the current stock price. Perhaps I’d go with the June 210 strike for WDAY, which would net me a premium of $5. However, if the market is weak, I might sell a call at the 185 strike for $14, as this sale would net me a much bigger premium/insurance policy.

“3. Is this a trade that you want to make a small premium quickly? If so, sell a short-term option as it will lose its value very fast (much like the AAPL example above). If it’s a long-term stock position that you want to hold onto for a while, then sell further out in time and further out-of-the-money. Perhaps the AAPL January 220 Call for $3.”

At the end of the day I think the #1 criteria above is most important. If you set a price target, and sell at that strike, then you have made a choice that you can live with. And you will have picked up a nice yield in the meantime.

If you have any questions about how to sell covered calls against your stock holdings please don’t hesitate to email me. And if you want my latest trade recommendations, you can subscribe to my Cabot Options Trader advisory by clicking here.

Jacob Mintz

Quick Profits, Controlled Risk

Jacob Mintz is a professional options trader and Chief Analyst of Cabot Options Trader. He uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can gain from following Jacob’s advice.

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  • Jacob M.

    Correct. As I said, “For example, if I owned 100 shares of Workday (WDAY) I could sell one call against my 100 shares.”

  • Ernest L.

    Be careful and don’t do this unless you have at least 100 shares, and then only in 100-share increments. One options contract is for 100 shares.

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