Let’s talk about the covered call strategy!

Hello everyone! Its been a while since my last post and life has been some kind of crazy this year. My day job has been a roller coaster of work, work, work, then the re-working of that work, but I’m sure most of you are enduring the same. However, unlike my day job the markets have been moving to the upside since the Coronavirus pandemic was first announced and for that my accounts are thankful.

Can I Retire Yet?

Now, lets focus in on the information I have to share with you today. If you don’t already know, I prefer options trading over just about any other investment vehicle and its because I feel like I have a higher level of control over the outcome. In those times when that isn’t true, I’m able to structure a new trade or simply re-structure an existing one. But that got me to thinking a great deal about the power of combining both my love for options trading with my need to be a longer term investor.

What I came up with is, in my opinion, AMAZING! But I’ll let you decide if it works for you as you read the next few paragraphs.

Side Note

First, this system for trading is undeniably risky for those with smaller accounts. NOT IMPOSSIBLE, just more complicated. Additionally, smaller accounts wouldn’t be able to achieve any level of diversification, at least not right away. I say that not to sway you away from the methodology but rather to highlight the “riskier” nature of non-diversified investing. On the other hand, Warren Buffet once said, “Diversification is protection against ignorance. It makes very little sense for those who know what they’re doing”. Take that as you will but when this post is done, you’ll be much closer to the “know what you’re doing” crowd.

The Idea?

The overarching goal of this system is to generate, hmmm, passive income. Realistically, we should call it “easyish income” because it does require at least monthly maintenance and I suppose that could be difficult for someone. In any case, the system hopes to generate consistent income at all times, either through dividends, or through the combination of dividends and naked calls.

The Covered Call Strategy

Is an options strategy consisting of selling a short call at any preferred interval on a stock you own. If ever those shares are exercised you’ll sell them at the short call’s strike price. Rinse and repeat perpetually. And that’s the strategy in a nutshell. I will forgo a conversation about the pro’s and con’s because remember, we are ok to hold the stock long term. For those uninitiated, that means we’re willing to hold the shares through the good and the bad, the ups and the downs.

For a more detailed review of the covered call strategy visit this page at Investopedia.com

Additionally, here is a post I wrote discussing covered calls.

The Investment Criteria

  1. Identify Capital Requirement. What amount of money do I have available to invest into this system? For the sake of discussion let’s assume I have $5,000 earmarked for this investment system.
  2. Identify Number of Assets. Do I want to diversify or put everything into one company? Remember what Mr. Buffett said? For this post, I will trade just one company.
  3. Identify Dividend and Option-ability. This is easily achieved by creating a scan that sorts the market by both dividend yield and optionable. Finviz.com offers a free screener with the ability to do this in just a few seconds. Below is an example but any of the available criteria can be useful.
Covered Call Screen using Finviz.com

The Bottom Line

I will trade At&t (Ticker: T) to further explain this post. Trade selection is contingent on your own research and individual goals or abilities. (All option contracts held until expiration and traded at the money.)

At&t (T)

Initial Share Price 1/4/2019 – $30.34

Opening DateShares (100)Short CallShares SoldDividendCost Basis
1/4/2019($3,034)$57$51($2,926)
2/15/2019$32($2,894)
3/15/2019$31$3,100$52$289
4/18/2019($3,203)$29($2,885)
5/17/2019$57$3,200$372
6/21/2019($3,245)$25$52($2,796)
7/19/2019$69$3,300$573
8/16/2019($3,497)$78$3,500$654
9/20/2019($3,791)$59$3,800$52$774
10/18/2019($3,847)$91$3,900$918
11/15/2019($3,950)$46($2,986)
12/20/2019$18$52($2,916)
1/17/2020$60($2,856)
2/21/2020$52($2,804)
3/20/2020$204$2,900$52$352
4/17/2020($3,123)$92($2,679)
5/15/2020$74$2,900$295
6/19/2020($3,031)$61$52($2,623)
7/17/2020$79($2,544)
8/21/2020$40($2,504)
9/18/2020$47$52($2,405)
10/16/2020$60$2,800$455
Covered Call Strategy (including dividends) on 100 Shares of At&t

What We’ve Learned

As is seen, I was able to conclude with $455 dollars. This while At&t’s share price actually dropped over the same period. Had I just purchased the 100 shares and held to receive the dividends I would have finished with $213 dollars.

While this may not seem like such an insane difference in dollars, I actually made 46% more money using the covered calls. To illustrate what that might look like over time, consider the following; (calculated using percentage return of initial investment and monthly contribution of $400)

YearBuy and Hold + Dividends + ContributionCovered Call + Dividends+ Contribution
1$106$227
15$142,358$225,123
15 year Compounding Return for At&t Stock

Over time that seemingly small difference becomes a staggering difference and could ultimately be the deciding factor for when you’re able to retire. Of course, each year will not go exactly as this small sample illustrates so returns could be wildly different but I believe it accomplishes the point I’d hoped to make.

Essentially, by utilizing the covered call method and consistently holding the stock the investor is double dipping dividends. At least, that’s what I would call it. In any case, I hope you were able to find some value in the material and don’t hesitate to reach out if you ever have any thing to share.

God bless,

Jeff