What is a Covered Call? 10 Best Stocks For Covered Calls

In this article, we discuss what is a covered call and 10 best stocks to buy or covered calls. You can skip our detailed analysis of the covered call strategy and its performance over the years, and go directly to read 5 Best Stocks for Covered Calls. 

What is a Covered Call Strategy?

A covered call strategy is an options trading strategy where an investor holds a long position in a specific stock or other underlying asset and simultaneously sells a call option on that same asset. The objective of this strategy is to generate income from the premiums received from selling the call option while potentially benefiting from the stock’s price appreciation up to a certain point.

The covered call strategy has gained attention because it has historically provided appealing returns when considering the level of risk involved. The CBOE S&P 500 BuyWrite Index (BXM), a benchmark index designed to track the performance of a hypothetical covered call strategy, is often said to offer similar average returns as the S&P 500 Index but with about two-thirds less volatility, according to a paper published by CFA Institute. The index has delivered an 8.29% return to shareholders since the start of the year and its 12-month return came in at 11.78%, as of September 22. The report also mentioned that the covered call strategy has gained attention among investors over the years. In the 10 years that ended June 2014, the assets managed using these strategies have grown by over 25% each year.

Another Goldman Sachs study from January 2012 looked at 16 years of covered call trading (from 1996 to 2011) and found that using covered call strategies improved returns and reduced risk in diversified portfolios. The advantage amounted to a 3.6% annual increase in returns and a 20% decrease in the variability of monthly returns. This improvement was based on selling covered calls that were 10% out-of-the-money and had a one-month duration on S&P 500 stocks with readily tradable options. In addition to this, the study discovered that writing call options on large-cap companies was more effective than on small-cap companies. However, it didn’t find a significant difference in results between value and growth stocks.

The popularity of this investment approach is evident in the success of the JPMorgan Equity Premium Income ETF (JEPI), the largest covered call exchange-traded fund (ETF) in the US, with assets totaling $26.8 billion. It has not only attracted the most new investments of any actively managed ETF this year but has also become the largest actively managed ETF overall. According to VettaFi’s data, $9.7 billion has been invested in JEPI ETF this year so far. One of the main reasons for this huge inflow is that JEPI is structured to hold a “defensive” portfolio of stocks, further minimizing risk.

Given the current market situation with continuous interest rate hikes and growing inflation, analysts advise investors to add defensive stocks to their portfolios and sell call options on these defensive securities. Todd Rosenbluth, head of research at VettaFi, spoke about the strategy in his interview with the Financial Times. Here are some comments from the analyst:

“Covered call strategies really started to gain traction with investors last year when there was more downside in the market . . . they were a way for investors to get above average income without taking on undue risk.”

For a covered call strategy, investors should consider established, large-cap, and blue-chip stocks that have a history of stability and are less likely to experience extreme price fluctuations. Some of the best stocks for covered calls include The Coca-Cola Company (NYSE:KO), McDonald’s Corporation (NYSE:MCD), and Ford Motor Company (NYSE:F). In this article, we will discuss some other best stocks for covered calls.

Our Methodology:

For this list, we selected the best stocks for covered calls based on hedge fund sentiment toward each stock. The companies mentioned below are blue-chip stocks with a history of performing well over the long term. Moreover, these companies also pay dividends to shareholders. Dividend stocks are well-suited for a covered call strategy because they offer a reliable income stream through dividends, which can complement the income generated from selling call options. The stocks are ranked in ascending order of the number of hedge funds having stakes in them, according to Insider Monkey’s database of Q2 2023.

10. Ford Motor Company (NYSE:F)

Number of Hedge Fund Holders: 40

Ford Motor Company (NYSE:F) is one of the largest automotive manufacturers in the US. The company primarily manufactures and sells automobiles, including a wide range of cars, trucks, and SUVs.

In the second quarter of 2023, Ford Motor Company (NYSE:F) reported revenue of $42.4 billion, which showed a nearly 12% growth from the same period last year. Its cash generation also remained strong during the quarter with an operating cash flow of $5 billion and a free cash flow of $2.9 billion. In addition to this, the company’s balance sheet is also strong with nearly $30 billion of cash and over $47 billion of liquidity at the end of the quarter.

Ford Motor Company (NYSE:F) is also a dividend stock and currently pays a quarterly dividend of $0.15 per share. As of September 22, the stock has a dividend yield of 4.83%. Due to these strong credentials, it is among the best stocks for covered calls. In addition to F, other stocks to consider for covered calls include The Coca-Cola Company (NYSE:KO) and McDonald’s Corporation (NYSE:MCD).

At the end of Q2 2023, 40 hedge funds in Insider Monkey’s database reported having stakes in Ford Motor Company (NYSE:F), up from 38 in the previous quarter. The consolidated value of these stakes is over $895.5 million.

9. ConocoPhillips (NYSE:COP)

Number of Hedge Fund Holders: 62

ConocoPhillips (NYSE:COP) is an American oil and gas company that is primarily engaged in the exploration, development, and production of oil and natural gas. The company pays dividends to shareholders and has reported strong cash generation in its most recent quarter. It generated nearly $4 billion in operating cash flow and distributed $2.7 billion to shareholders, including $1.4 billion through dividends. Moreover, it had over $7.1 billion in cash and short-term investments.

On August 3, ConocoPhillips (NYSE:COP) declared a quarterly dividend of $0.51 per share, which was in line with its previous dividend. The stock has a dividend yield of 3.81%, as of September 22.

As of the close of Q2 2023, 62 hedge funds in Insider Monkey’s database reported having stakes in ConocoPhillips (NYSE:COP), worth collectively over $2.62 billion. With roughly 15 million shares, Harris Associates was the company’s leading stakeholder in Q2.

8. Lowe’s Companies, Inc. (NYSE:LOW)

Number of Hedge Fund Holders: 64

Lowe’s Companies, Inc. (NYSE:LOW) is next on our list of the best stocks for covered calls. The American retail company operates in the home improvement and hardware retail sector. It has been raising its dividends for 59 years, with a five-year average annual dividend growth rate of 21.5%. This shows that the company is financially stable, profitable, and has a shareholder-friendly approach. The stock’s five-year returns came in at 85.1%.

In the second quarter of 2023, Lowe’s Companies, Inc. (NYSE:LOW) reported revenue of $25 billion, which was in line with analysts’ estimates. The company ended the quarter with roughly $3.5 billion available in cash and cash equivalents, compared with $1.5 billion a year ago.

Insider Monkey’s database of 910 hedge funds showed that 64 funds owned stakes in Lowe’s Companies, Inc. (NYSE:LOW) at the end of Q2 2023. The total worth of these stakes is over $3.7 billion.

Pershing Square Holdings mentioned Lowe’s Companies, Inc. (NYSE:LOW) in its first half of 2023 investor letter. Here is what the firm has to say:

Lowe’s Companies, Inc. (NYSE:LOW) is a high-quality business with significant long-term earnings growth potential operated by a superb management team that has been successfully executing a multi-faceted business transformation. In recent quarters, industrywide sales have retrenched slightly, driven by record lumber deflation, moderation in DIY discretionary demand (particularly with big-ticket items), a mix-shift from large to smaller Pro-specific projects, and a general trend of consumers reallocating budgets from goods to services. Sales remain elevated relative to 2019 baseline levels driven by a combination of price and mix, while units have largely normalized. Against this backdrop, Lowe’s headline same-store-sales growth has been modestly negative, offset by material margin expansion and the benefits of Lowe’s best-in-class share buyback program positioning the company to generate roughly flat earnings growth in 2023. (Click here to read the full text)

7. PepsiCo, Inc. (NASDAQ:PEP)

Number of Hedge Fund Holders: 68

PepsiCo, Inc. (NASDAQ:PEP) is an American multinational food and beverage company that is known for its wide range of popular brands. The company was a part of 68 hedge fund portfolios at the end of Q2 2023, as per Insider Monkey’s database. The collective worth of these stakes is over $3.5 billion.

PepsiCo, Inc. (NASDAQ:PEP) has generated strong results in the second quarter of 2023 with revenue of over $22.3 billion, up 10.3% from the same period last year. For FY23, the company expects to return $7.7 billion to shareholders through dividends and share repurchases. In the past five years, the stock has delivered a 56.7% return to shareholders.

PepsiCo, Inc. (NASDAQ:PEP) is a strong dividend payer with a 51-year track record of dividend growth under its belt. The company offers a quarterly dividend of $1.265 per share and has a dividend yield of 2.89%, as of September 22.

6. Walmart Inc. (NYSE:WMT)

Number of Hedge Fund Holders: 81

Walmart Inc. (NYSE:WMT) is sixth on our list of the best stocks for covered calls. It is one of the world’s largest and well-known retail corporations. In the second quarter of 2023, the company posted revenue of $161.6 billion, which showed a 6% growth on a year-over-year basis. Its operating cash flow for the quarter came in at $18.2 billion and it generated $9 billion in free cash flow.

Walmart Inc. (NYSE:WMT) is a dividend stock and has raised its payouts for 50 years straight. It currently pays a quarterly dividend of $0.57 per share and has a dividend yield of 1.40%, as of September 22. In the past five years, the stock has delivered a 72.8% return to shareholders. The Coca-Cola Company (NYSE:KO), McDonald’s Corporation (NYSE:MCD), and Ford Motor Company (NYSE:F) are some other stocks to consider for covered calls.

At the end of June 2023, 81 hedge funds tracked by Insider Monkey reported having stakes in Walmart Inc. (NYSE:WMT), compared with 91 in the previous quarter. The collective value of these stakes is over $5.4 billion. Among these hedge funds, D E Shaw was the company’s leading stakeholder in Q2.

Click to continue reading and see 5 Best Stocks For Covered Calls. 

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Disclosure. None. What is a Covered Call? 10 Best Stocks For Covered Calls is originally published on Insider Monkey.