Investors seeking to increase their income in a low-interest-rate environment may want to consider utilizing covered call strategies with their stock portfolios. This approach, also known as call writing, involves selling call options on stocks that investors already own. By doing so, investors can generate additional income through the premiums received from selling these options. However, it’s important to note that this strategy limits the potential upside of the underlying stock, as the call option gives the holder the right to buy the stock at a predetermined price.
While covered call strategies may underperform in rapidly rising markets, they can still yield significant profits in various market conditions. According to Bank of America, these strategies tend to outperform outright stock ownership in flat, down, and slightly up markets. This makes covered call strategies attractive for investors looking to enhance their returns while managing risk.
To identify suitable candidates for covered call strategies, investors can look for stocks with options that allow for at least a 7% upside and offer a minimum premium of 5%. Bank of America’s derivatives analyst, Arjun Goyal, has recommended call options on stocks in the Russell 1000 index with mid-October expirations. Some of the potential candidates include Avis, Dick’s Sporting Goods, and Neurocrine Biosciences. However, it’s essential to consider factors such as market price fluctuations and upcoming corporate events that may impact option pricing.
While implementing covered call strategies, investors should be aware of the mechanisms for managing their positions. If a stock price approaches or exceeds the strike price of the call option, investors have several options to avoid having their stock “called away.” One approach is to buy a call option with the same details as the one written previously, effectively canceling out the position. Additionally, investors can “roll out” their covered call position by selling another option with a later expiration date or “roll up” the position by selling a call option with a higher strike price.
It’s crucial for investors to carefully assess the risks and rewards associated with covered call strategies before implementing them in their portfolios. While these strategies can provide additional income and downside protection, they also have limitations in terms of potential upside. Additionally, market conditions and option pricing dynamics can impact the effectiveness of covered call strategies, requiring investors to stay informed and adapt their positions accordingly.
Covered call strategies offer investors a way to generate income from their stock portfolios while managing risk. By identifying suitable candidates, understanding the benefits of these strategies, and effectively managing their positions, investors can enhance their overall returns and navigate various market conditions successfully.