The high-yield opportunities we have witnessed over the last couple of years will disappear when the Federal Reserve starts signaling rate cuts. Do not worry, however: there is a tested way to maintain steady cash flow—that is, using high-yield stocks with covered calls.
In this tutorial, we’ll guide you on how you can earn up to 24% annual income using this simple options strategy.
Understanding High Yield Stocks and Covered Calls
What Are Covered Calls?
A covered call strategy is the process of owning shares of a stock while selling call options on those shares. The call options give the buyer the right (but not the obligation) to buy your stock at a specified price within a set time frame.
When you sell these calls, you’re collecting the premium upfront; you can supplement your income while you collect those dividends on the stock.
Why High-Yield Stocks?
High-yield dividend stocks, such as Altria symbol: MO, offer attractive payouts. These tend to pay relatively consistent dividends. With high-yield dividend stocks, you find excellent candidates for covered call strategies.
How It Works: An Example with Altria
Step 1: You Buy the Stock and Then You Sell Calls
- July 2022 Altria traded at $42.98 per share.
- A trader can purchase 1,000 shares, and sell 10 call options at a strike of $45 that expire in November for $1.49.
Step 1: Opening Cash Flow
- Cost of Stocks Purchased: $42,980
- Calls Premium Collected: $1,490
- Net Cost: $41,490
Step 2: Collect Dividends
Altria Inc. paid a quarterly dividend of $0.94 per share. For 1,000 shares, this translates to $940 each quarter.
Step 3: Options Expiration
On 18 Nov, Altria closed at $44.20, below the strike price at $45. The options expired worthless, leaving the trader with the premium and the shares.
Steps to be Followed
Sell another set of call options that expire in March for the $1.81 price. In this case, the trader makes that $1,810.
Step 4: When the Stock Rises
Adjust:
If the stock price is greater than the strike price before expiring, the trader can “roll” the options. This is a process in which the existing options are bought back and new ones are sold ahead but with a later expiring date.
Example
- Buy Back March Options: Cost $1,220
- Sell June Options: Premium $2,330
- Net Gain from Rolling: $1,110
Step 5: Closing the Position
In June, Altria’s stock closed at $44.07, and the trader sold the shares. It included:
- Dividends over four quarters.
- Premiums from selling call options.
- A small capital gain from selling the shares at $44.07.
The Final Results
Dividend-Only Approach
- Total Return: 11.3%
Covered Call Strategy
- Total Return: 21.5%
The covered call approach nearly doubled the return by combining dividends with call premiums.
Why This Strategy Works
Covered calls are perfect for investors looking for:
- Income Generation: Premiums from options supplement dividends.
- Risk Management: The premium reduces the net cost of owning the stock.
- Flexibility: Rolling options allows you to adapt to market conditions.
How to Begin with Covered Calls
Select a High-Yield Stock
Select stable dividend payers such as Altria.
Sell Call Options
Sell call options at strike prices just above the current prices of the stock for maximum premium.
Monitor and Roll or Close
Roll or close options where necessary to keep control of your shares.
Conclusion
It doesn’t have to be rocket science to make money with high-yield stocks. Dividends, when combined with covered call strategies, can produce some pretty impressive returns, even in a declining interest rate environment.
Start small, refine your approach, and you’ll soon see why covered calls are a favorite among traders seeking steady income.