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
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
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.
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:
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.
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
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.