Covered Calls
Even for the buy-and-hold advocates a better solution exists than simply relying on dividend paying stocks. During bull markets, investors feel safe holding shares of titans of American industry such as Exxon, Microsoft, Procter & Gamble, and so forth. Annual, semi-annual or quarterly dividends instill confidence that the company is earning a profit and paying out a portion of those profits to faithful shareholders. But is this faith really justified?
Some companies engage in shenanigans! They actually report losses but still pay out dividends. How can this be? Simply put they borrow money to pay those dividends in order to maintain the facade of normalcy. This is a dangerous game for unsophisticated traders because they are not aware of the manipulation needed to produce the dividend. Unsophisticated investors will look just at the dividend percentage return and fail to focus on the fundamental underpinnings which may well be weak. They also have no control over whether that dividend is actually paid. As we have seen with bank failures in 2009, dividends may be quickly slashed when companies need cash, leaving investors holding shares that may be depreciating too. So, is there a better way?
Certainly! And it comes in the form of a Covered Call. This strategy simply combines a stock holding with an option, the short call. A Covered Call strategy offers investors interested in holding stock positions a means of proactively generating income on a regular basis. No longer are investors dependent on the company to pay out dividends. An investor can simply hold an existing stock position but sell call options at what are called strike prices. These are fixed prices at which the investor agrees to sell the underlying stock if the stock should rise above that level within a set time period defined at the outset of the trade.
The Covered Call is immensely powerful because investors have the choice not just of generating income on an annual basis as may be the case with some dividend paying stocks but on a monthly basis. The frequency of payments means that income payments have the opportunity to compound at a greater rate, thereby magnifying returns. Covered Calls are attractive also because investors have the opportunity to define the income percentage they are targeting. For example, some investors may be interesting in selling calls that generate a small premium while relying on capital appreciation in the underlying stock to produce profits. Others might prefer to generate higher income upfront in exchange for a commitment to sell a stock at a lower price. Risk tolerances tend to play a significant role in such decisions.
This article merely scratches the surface of the Covered Call but it is possible to be extremely creative and tailor the strategy to one's own risk and reward preferences. If you own stock as a buy-and-hold strategy, mastering the Covered Call is a MUST. To learn more about the Covered Call strategy and its numerous applications that suit your risk tolerance, simply join our group of expert traders who will guide you in a way that best suits your needs.
