In 2019, interest rates were cut for the first time in a decade. Central bankers across the globe are hinting that they too are ready to cut rates if needed. 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. This is a VERY conservative strategy. For example, if I owned 100 shares of Snap (SNAP) I could sell one call against my 100 shares. And when I sell that call I collect a premium (essentially collecting an insurance premium).
In fact, if you’d been selling covered calls against our Snap (SNAP) stock position, you’d be creating yields of over 3% month after month. In this low interest rate environment, the ability to create yield of 3% every month is a home run!
How Do I Determine Which Strike I Should Sell Against My SNAP Stock Position?
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:
- At what price am I willing to sell the stock? If I am willing to sell SNAP at 17, then I would sell the 17 strike. If I am willing to sell the stock at 18, then I would sell the 18 strike.
- Is the market stable? If the market is stable, and trending higher, then I am more likely to sell a call further away from the current stock price. However, if the market is weak, I might sell a call at the 17 strike closer to the stock price, as this sale would net me a much bigger premium/insurance policy.
- Is this a trade that you hope will make a small premium quickly? If so, sell a short-term option as it will lose its value very fast.
At the end of the day 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.