Time To Sell Some Covered Calls For The 1% Portfolio

Summary

  • McDonald’s, Coca Cola & American Express all currently have inflated option premium. We are going to sell covered calls to bring in more income.
  • We get paid the dividend from McDonalds on the 15th. We strategically sell our covered call option to make sure it doesn’t coincide with earnings in January.
  • American Express goes ex-dividend in January and then has earnings the following week. We strategically sell our covered call to make sure we collect the dividend and miss earnings.

We have 3 underlyings in our portfolio that are ripe for option premium at the moment. McDonald’s (MCD), Coca-Cola (KO) & American Express (AXP) are all with inflated option premium due to the volatility we have had in the stock market recently. We have to be careful though as all 3 of these underlyings have dividends and earnings coming up soon. We bought these underlyings for the 1% portfolio a few weeks ago. This strategy is only for investors who own at least 100 shares. The call options need to be “covered” and not naked to ensure we have no risk with these trades. Let’s go through each underlying and set up each covered call trade accordingly but first lets look at some charts and explain why covered calls are a good play at this juncture

As you can see from the above charts, all of our underlyings have been in strong bull mode since 2010 with American Express doubling in that time frame. Why sell covered calls now? Selling covered calls is a neutral to bullish strategy. This strategy caps our gains but it brings in an income which is the purpose of this portfolio. After the S&P going from 666 in 2009 to now well over 2000, the risk is firmly to the downside. The time to sell covered calls is when you are neutral on your stock (or slightly bullish). Yes, we may get one final blow off phase (bubble phase) in the S&P but it may be short lived. Also we are in a tapering environment. If quantitative easing was the main reason for the rise in stocks since 2009, well then tapering should mean stocks should stay neutral or fall from here. This is why I recommend ” renting out” some of your underlyings when the opportunity arises. We hold our stocks when we believe they are in full bull mode. We rent them out (sell covered calls) when we believe a correction may be due.

First up is Mcdonalds which is currently trading at $91. This stock will pay out its dividend next Monday the 15th so we are in line to receive our dividend. Nevertheless we are going to use the strength in the market to sell a call option against our stock. This is otherwise known as renting out your shares for income. McDonalds option premium has spiked in the last week so we are going to bring in some income by selling an out of the money call. Our average stock price for is $92 per share so we are going to sell the 95-Jan-15-Call for $58. This gives us a full $3 of stock appreciation and also the option premium if we are assigned. $58 may not sound like much but with a hypothetical 4% dividend for example, Mcdonalds only yields $364 at current prices. Moreover, we should be able to sell these calls about 7 to 8 times a year depending on how much premium we can collect. We are selling the 95-Jan-15-Call because earnings are being announced the following week. Option premium usually inflate going into earnings so we don’t want to sell options the same week as earnings. Again we put in a GTC order (Good until cancelled) to buy the call for a 50% profit which would be $29.

Next up is Coca Cola which again is paying its dividend on the 15th. Next earnings here are not until February so we don’t need to be worried about inflated option premium here. We usually go out 30 to 45 days so we will sell the Jan-23-43.50-Call for $34. Our entry price is around the $43 mark and the stock is currently trading at $41.90. Once you are filled, immediately put in a GTC order to buy back your sold call for $17.

Finally is American Express. This stock has performed well over the last few weeks and we are currently up on this trade. This stock goes ex-dividend on the 07-01-2015 and has earnings the following week. If the stock spikes from here, we want to make sure we are holding the stock on the ex-dividend date. Therefore we are going to sell the Jan-09-96-Call for $95. If the stock is at $96 or more by expiration, we will lose our shares temporarily but we will still get our dividend. Moreover, we will have pocketed the $95 premium and the capital gain of the stock. Again once you are filled, put in a GTC order to buy back your sold covered call for $48.

Updated Portfolio (12-11-2014)

Open Positions (Position size kept Ultra Small)

Underlying Strategy Result
GDXJ – 19/11/2014 Sold 25-DEC26 Naked Put Open
UNG – 20/11/2014 Sold 21-DEC26 Naked Put Open
USO – 25/11/2014 Sold Jan02-27.5 Naked Put Open
USO – 10/12/2014 Sold Jan16-22 Naked Put Open
MCD- 11/12/2014 Sold Jan15-95 Covered Call Open
KO – 11/12/2014 Sold Jan23-43.50 Covered Call Open
AXP – 11/12/2014 Sold Jan09-96 Covered Call Open
GDX Bought Stock 09/12/2014 Open
MCD Bought Stock 25/11/2014 Open
KO Bought Stock 25/11/2014 Open
K Bought Stock 25/11/2014 Open
TBT Bought Stock 28/11/2014 Open
KOL Bought Stock 25/11/2014 Open
AXP Bought Stock 05/12/2014 Open
BDX Bought Stock 05/12/2014 Open
IBM Bought Stock 05/12/2014 Open

Closed Positions (Per One Lot Of Options Sold)

Underlying Strategy Result
GDXJ 17/11/2014 Sold 22-DEC26 Naked Put $38 Profit
MCD – 20/11/2014 Sold 94-DEC26 Naked Put $48 Profit
KO – 20/11/2014 Sold 43-DEC26 Naked Put $21 Profit

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