Thursday, August 18, 2011

How to decide if a covered call premium is enough?

          Readers of TheMoneyMadam's blog know that our sole focus is creating income and doing it with simple income investing techniques.  During turbulent times, selling calls (read my post on how to write, also known as sell, a covered call) is a good opportunity to create income.  I am often asked how to decide if the premium is enough?


          I use a very simple guideline.  I expect the call premium to create income equal to or greater than two dividend payments.   My rationale is that I can double my income by writing only two calls per year on that stock.  That means on a dividend stock that pays me three percent, I can earn six percent income if I write two calls in a year and each call premium is equal to two dividend payments.

          Nothing better than learning by example so let us look at a trade I made today.  I bought some more Intel, symbol INTC at $19.75.  Intel pays an annual dividend of $.84 for a yield of 4.06 percent. Each quarterly dividend is $.21.  Since INTC is one of our dividend machines, I could have just added to my position.  But I decided to make even more money by selling calls against these new shares.  I own enough INTC that I am willing to lose it if the call buyer wants to buy it in November.  A November 22 call pays me $.44 just a bit above two dividend payments.  If they buy it from me at $22, my gain is a tidy 13.6 percent.  If the economy still stinks, and I keep my new shares of INTC, my income just from selling this call will go from 4.06 percent to 6.48 percent.  If I can do it again within the next year, my income goes up to 8.7 percent. 

          This is a simple idea for simple income investing.   When you realize that you are buying a company more solid than the U.S. government and that your income will go up every year just from dividend payments; and you have capital gain potential why would you invest in any other way?

Very Truly Yours,
TheMoneyMadam


Enhanced by Zemanta