Boost Your Income with Covered Calls

07/15/2013 10:00 am EST


Stephen Mauzy

Income-Investing Specialist, Wyatt Investment Research

Steve Mauzy of the Daily Profit explains how a covered-call strategy can be a simple and safe proactive way to boost your income from blue-chip stocks.

A covered-call strategy is my favorite way to boost income and yield on the world's best dividend-paying stocks. This is a simple and safe strategy to double your income.

The good news is that any investor can profit with a covered-call strategy: All you need is enough capital to buy 100 shares and an online brokerage account.

Here's how it works. You simply buy 100 shares of a stock like McDonald's (MCD), Altria (MO), or AT&T (T)-companies that faithfully boost their dividends each year.

You then sell one call option on the 100 shares. In exchange for selling the call option, you receive an upfront premium payment.

I understand that many investors are put off by options-they view them as risky or difficult-to-trade instruments. Don't be put off, because options aren't risky in the context of a covered call, nor are they difficult to trade.

Most online brokers permit options trading. In most cases, if you already have a margin account with your online broker, you can start trading immediately. I'll use McDonald's to demonstrate just how simple it is to implement and profit from a covered-call strategy.

McDonald's is one of my favorite dividend stocks. It has increased its dividend annually every year since 1976. Needless to say, McDonald's isn't just a favorite of mine. It's a favorite of many income investors, which is why it yields only 3.1% based on a recent $97.50 share price and a $3.08 annual dividend.

By overlaying McDonald's shares with a covered call, though, you can more than double your income and yield. As I write, you can sell an August 2013 105 call option on McDonald's for the equivalent of 63 cents a share (each call option covers 100 shares). This gives the buyer the right to call away 100 shares of McDonald's at a price of $105 a share for the next two months. In exchange, you receive a $63 payment.

Now, imagine selling a similarly priced call option on McDonald's six times-every two months-over a 12-month period.

Every two months, you'd receive $63 (less the brokerage fee), so over 12 months you'd receive $378 in premium payments. Of course, you'd also receive the $308 in dividends on the 100 McDonald's shares you own.

Over a 12-month period, instead of receiving $308 in income on your McDonald's share, you'd receive $686. You've more than doubled your income, and you've hiked the current yield to 6.9% from 3.1%.

The risk in the strategy should be apparent: McDonald's share price could rise above $105, and the shares would be called away. In that case, though, you would still book an additional $5.50 per share, so you wouldn't suffer a monetary loss.

That said, McDonald's is a low-volatility stock, with a beta below 0.50. In other words, its share price tends to move half as much as the overall market.

And because you are resetting the strike price-the share price at which the shares can be called away-every two months, the probability is high that your shares won't be called away.

Altria and AT&T are low-volatility stocks as well. The share price of both these companies also tend to move half as much as the overall market. What's more, Altria and AT&T shares are highly liquid-like McDonald's shares-so their options are also highly liquid.

So don't buy into the fear-mongering about options. In a market starved for income, covered-call strategies offer the opportunity to safely increase income on the world's best dividend-paying stocks.

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