As I wrote last June, “Writing covered call options entails selling the right to buy shares of a stock you own within a set period of time. This is transacted through a call option of which the option buyer has the right to buy the underlying stock of the contract at a set price. On the flip side, the option writer has the obligation to sell the underlying stock at the contract price upon exercise from the option buyer.”
According to Mike Scanlin of www.borntosell.com, “Covered calls are an easy and conservative income-oriented investment strategy.” This website provides a calculator for Foolish investors to determine what could potentially be earned by writing covered call options. Utilizing that tool, a Foolish investor owning 1,000 shares each of Chevron Corporation (NYSE:CVX), Occidental Petroleum Corporation (NYSE:OXY), Microsoft Corporation (NASDAQ:MSFT) and Intel could possibly generate substantial income from writing covered call options on each, as shown by the table below.
| Call Expiration Date | Chevron | Occidental Petroleum | Microsoft | Intel Corporation |
|---|---|---|---|---|
| April 20 | $1190 (12.6%)* | $1040 (16.4%) | $450 (20.10) | |
| May 19 | $1930(10.2%) | $1960 (16%) | $630 (19.9%) | |
| June 20 | $2380 (7.9%) | $3500 (11.3%) | $800 (15.1%0 |
Source: www.borntosell.com (*annualized return)
While those returns are just projections, we know that income can be earned in different ways when writing covered call options. The first is from the actual sale of the covered call option. As about 80% of options are never exercised, this is a very good way to profit from owning a stock since the odds are strongly in favor of the holder getting to keep the stock after the expiration date.
Next, gains are made if the stock is sold at a higher price than when it was purchased. If Chevron Corporation (NYSE:CVX) was around $100.00 per share and sold now at $121.00, there would a profit of over $20 per share from the transaction. That goes to the owner of the stock, not the buyer of the call option. If Chevron were to fall in price, the call option would not be exercised.
In addition to the capital gains, the owner of the shares gets to keep the dividend income that’s paid during the option period. For Chevron, Occidental Petroleum Corporation (NYSE:OXY), Microsoft Corporation (NASDAQ:MSFT) and Intel, that’s not a minor consideration as each has a robust dividend. While the average dividend for a member of the S&P 500 is around 2%, for Chevron Corporation (NYSE:CVX) it is 2.97%, Occidental Petroleum Corporation (NYSE:OXY) it is 3.25%, Microsoft Corporation (NASDAQ:MSFT) it is 3.26% and for Intel it is 4.22%.
When you write covered calls, your goal is to keep your shares and still book the income from selling the options and cashing the dividend checks. Stocks that have risen, but do not appear to have much upside left, with strong dividend income are the ideal candidates. As the table below shows, Chevron, Occidental Petroleum Corporation (NYSE:OXY), Microsoft Corporation (NASDAQ:MSFT) and Intel are all up for 2013. Chevron is very close to its 52-week high, with Microsoft near its peak for that same time period.
| Metric | Chevron | Occidental Petroleum | Microsoft Corporation | Intel Corporation |
|---|---|---|---|---|
| Gain for 2013 | 12.94% | 3.47% | 6.64% | 4.56% |
| % Below 52-Week High | 0.16% | 18.98% | 11.54% | 24.95% |
Source: Finviz
Based on that, and indicators that point to it being overvalued, such as a relative strength index rating of 70.46, signaling that it has been overbought and both its price-to-sales and price-to-book ratio being higher than the industry average, according to The Motley Fooll CAPs, Chevron Corporation (NYSE:CVX) looks to be a promising stock for the Foolish investor to book profits from writing cover call options and still keep the shares.
The article Cover Calls Attractive with Market High originally appeared on Fool.com and is written by Jonathan Yates.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
