Covered-call writing can be crafted to meet a myriad of goals in a wide range of market conditions. In May of 2020, the 10-year Treasury bond yield was 0.65%. Bank interest rates in several countries were negative, explains Alan Ellman of The Blue Collar Investor.
At the same time, dividend yield on Dow 30 and S&P 500 (SPX) dividend-bearing stocks were triple that of the 10-year Treasury. I see this as an opportunity…a three-income stream opportunity derived from share appreciation, option-premium, and dividend capture.
Three-Income Strategy in Low-Interest-Rate Situations
Blue-chip stocks frequently are cash-rich and generate dividends on a quarterly basis. They have a long history of success and, in addition to the dividends, most have exchange-traded stock options associated with them. This proposed strategy consists of the following steps:
- Buying a portfolio of the best-performing Dow 30 stocks
- Selling out-of-the-money call options
- Capturing corporate dividends
- Managing our covered-call positions
Stock Selection
We select the top-performing Dow 30 stocks that have been out-performing the S&P 500 in both three-month and one-year time frames as shown in our BCI Blue Chip Reports.
Top-Performing Dow 30 Stocks for the June 2020 Contracts
Option Selection
For this article, I used the first five stocks in the report and checked the option-chains for out-of-the-money strikes that generated 1%-2% for one-month initial time-value returns. I entered the option-chain information into the blue cells of the multiple tab of the Ellman Calculator.
Portfolio Calculations: 5 Stocks
The average one-month return on the option was 2.3% with an additional upside potential average of 3.5%. The maximum one-month return on this portfolio is 5.8% without exit strategies. On top of these income streams, we can add the dividend income offered by these companies.
Important Dates
Ex-dividend date
In order to capture the corporate dividends, we must own the shares prior to and on the ex-dividend date. A free and reliable resource is:
www.dividendinvestor.com.
Earnings report date
We should never have an option in place that expires after an earnings report date in a contract month. We should wait for the report to pass and then sell the call option or not use that stock until the report passes. A free reliable resource for ER dates is www.earningswhispers.com.
Exit Strategies
Once we have entered a covered-call trade, we move to position-management mode. A complete detailed discussion of exit strategies is beyond the scope of this article, but these include:
- 20%/10% guidelines
- “Hitting a double”
- Rolling down
- Selling the stock after closing the short call
- Mid-contract unwind exit strategy
- Rolling-out
- Rolling-out-and-up
Discussion
In a low-interest-rate scenario (can be used in others, as well) especially, we can set up a low-risk, three-income stream strategy using blue-chip stocks, out-of-the-money call options, and dividend capture for each position. As always, the three required skills are essential for achieving the highest returns:
- Stock selection
- Option selection
- Position management
Learn more about Alan Ellman on the Blue Collar Investor Website.
