Monday, August 12, 2019

A case for Selling Calls for the Income Investor

Call income seems to accompany dividends as the best income tools for August.  Bond interest is so low and quality dividend stocks are so expensive.  Therefore, I sell covered calls on existing positions hoping I do not lose too much opportunity by having my stocks called away.

August is a pretty typical month for call expirations.  History tells us 90 percent of calls expire without action and 10 percent are assigned.   In the table below, I have 18 calls with August expiration dates.

As of today, I have 4 in the money which means the current stock price is above the strike price and 14 out of the money where the current stock price is below the strike price of the call. See the table below.



Only one of these stocks does not pay a dividend and that is YELP.  When I realized YELP was not going to perform quickly, I sold a call very close to the current price and my basis and am hoping it is called away which means the call buyer not only paid me a premium for the option but will also pay me the strike price.  That makes me even on the stock and the call premium in my pocket.

Three other stocks have low dividend yields, MSFT, NVDA and SWKS.  I consider a yield low if it is below the 2 year U.S. Treasury yield so SWKS with a yield of 1.99% may not be considered a low yield stock for some.

I like MSFT but with such a low dividend, as an income investor, I am willing to lose part of my position to the call buyer.  I am underwater on NVDA and will hope the China situation improves at some point.  I will continue to sell calls that are close to my basis so that I can unload NVDA in a similar fashion to YELP.

FOUR IN THE MONEY CALLS

The four income money calls are:   MSFT $135, WDC (Western Digital Corp.) $52.50, CVS $57.50, and YELP $34.   Expiration dates are August 16, 2019 except where noted.  My reasons for risking losing these stocks to the call buyer are:

  • MSFT - yield is too low
  • WDC - yield is good but not growing, EPS are less then dividend paid out but growing
  • CVS - (August 23 expiration)stock price is weak, I added to my shares that are underwater, and sold calls against the low buys
  • YELP - no dividend and stock price is not performing as hoped 

The downside of selling covered calls is two fold. one is lost opportunity.  The call buyer was right to pay you the money for the option to buy, they execute the call and then the stock soars and you miss out on the growth.    If you always look back and are cannot afford to lose a favorite stock, don't sell calls against your beloved stock.

The second risk is your shares are on call, the stock price tanks, you would like to get rid of the stock but cannot unless you pay money to buy back the call.   This risk is untenable for an income investor.  We don't pay out, we deposit funds.  The moral is to pick the underlying stock carefully.

FOURTEEN CALLS OUT OF THE MONEY

The 14 out of the money calls are listed below.  Each stock pays a decent dividend and I am willing to keep them.  I am hoping for additional volatility that may allow additional call selling.  But I am not in such a hurry to lose these stocks so I pick strike prices that I think are harder for the stock to attain before the call expires.  Expiration dates are 8/16/2019 except where noted.

  • MSFT - $145 low yield but upside potential for this very well run company 52 week high $141.68
  • COP - $67.50 nice dividend increases of 7+% recently  
  • LVS - $62, $65, $67.50 High yield with enough volatility that strike prices well above my basis are available.
  • M - $23 High yield with an improving balance sheet and very low P/E (price earnings ratio)
  • WSO - $180 Nice yield, with good fundamentals, headline risk due to global exposure provides strike prices well above my basis
  • SWKS - $82.50, $85 Decent yield, good balance sheet, nice volatility, I have been able to sell calls two - three times per year
  • WMT- $115 Walmart does not raise the dividend much and the yield is mediocre, strike prices near the 52 week high of $115.42 pay enough premium to make WMT a hold.
  • WDC - $55 High yield and improving fundamentals
  • SWKS- $81 (August 23 expiration) Decent yield but enough volatility to enjoy call premiums more than once a year
  • RDS.A - $63.50 (August 23 expiration) Very Good Yield, calls available only about once a year and I sell calls on only part of my position always above my basis and hopefully pick a strike price high enough that I am not called away.
  • NVDA- $185 (August 30 expiration) my worst performing stock of the group.  Not enough dividend to care if it is called away.   
In my case 22.22% of the calls are likely to be exercised versus the historical average of 10% but we still have to see what happens the rest of August.  This post illustrates how conservative income investors can use call options to boost their income during a time when quality dividend stocks are expensive and quality bonds are outrageously expensive.

M* MoneyMadam