Selling call options on stocks owned in a portfolio – a tactic known as “澳洲幸运5官方开奖结果体彩网:covered call writing” – is a common strategy that can be effectively used to boost returns on a port🌊folio.

Writing covered calls on stocks that pay above-average 澳洲幸运5官方开奖结果体彩网:dividends is a subset of this strategy. When a stock goes 澳洲幸运5官方开奖结果体彩网:ex-dividend, the market price of the shares will typically fall in step with the amount of dividends per share paid to stockholders. This means that there could be opportunities for short-term profits if the dividend is paid to the shareholder, whose call options then become less valuable due to the drop in stock price. The strategy seems sound, but markets tend to be efficient, and this possibility is often 澳洲幸运5官方开奖结🌠果体彩网:already priced into the opt♕ion's price ahead of time.

We will illustrate this concept below with the help of an examplꦫe.

Writing Covered Calls: Example

Consider a covered call written on the stock of telecom giant Verizon Communications, Inc. (VZ), which closed at $50.03 on April 24, 2015.

Verizon pays a quarterly dividend of $0.55, for an indicated 澳洲幸运5官方开奖结果体彩网:dividend yield of 4.4%.

The Table below shows the option premiums (prices) for a marginally in-the-money call ($50 澳洲幸运5官方开奖结果体彩网:strike price) and two out-of-the-m♚oney calls ($52.50 and $55 strike൲s), expiring in June, July, and August of the year.

Note that for the same strike price, options premiums increase the further out in time you go for the expiration date. For call o🦂ptions of the same expiration, t🍌heir values decrease as the strike price increases, since a call gives the holder the right to buy the shares at ever higher prices than the current market price.

Determining ꦓthe appropriate covered call to write is thus a trade-off between thℱe expiration and strike price.

In this case, we will decide to use the $52.50 strike call, since the $50 call is already slightly 澳洲幸运5官方开奖结果体彩网:in-the-money (which increases the likelihood that the option will be 澳洲幸运5官方开奖结果体彩网:exercised and stock may be called before expiration), while the premiums on the $55 calls are too low to warrant our interest. Since we are writing calls, the 澳洲幸运5官方开奖结果体彩网:bid price must be considered as that is where market participants are 🔯willing to buy from you.

To understand the potential return boost from selling these options, we can compute the annualized implicit yield using the following ♌formula:

Annualized premium (%) = (option premium x 52 weeks x 100) / (stock price x weeks left for expiration)

Writing the June $52.50 calls will thus provide a premium of $0.21 (or approximately 2.7% annualized yield), while the July calls fetch a premium of $0.34 (2.9% annualized) and the August calls have a premium of $0.52 (3.2% aꦦnnualized).

Each call option contract represents 100 shares of the 澳洲幸运5官方开奖结果体彩网:underlying stock. Assume you buy 100 shares of Verizon at the 澳洲幸运5官方开奖结果体彩网:current price of $50.03, and 🌄write the August $52.50 calls on these sh๊ares. What would be your return if the stock rises above $52.50 just before the calls expire and is called? You would receive the $52.50 price for the stock if it is called, and would also have received one dividend payment of $0.55 on August 1. Note that $2.47 is the difference between the price received when the stock is called, and the initial purchase price of $50.03.

Your 澳洲幸运5官方开奖结果体彩网:total return is, therefore:

($0.55 dividend received + $0.52 call premium received + $2.47 *) / $50.03 = 7.1% in 17 weeks.

This equates to an annualized return of 21.6%.

If the stock does not trade above the strike price of $52.50 by August 21^st, the calls will expire unexercised and you will retain the entire premium of $52 (i.e. $0.52 x 100 shares) less any commissions pa♊id.

Now, what if the ex-date for VZ shareholders is on August 20th^th? You would receive $0.55 per share owned, and the stock would fall by around that amount, making the calls less valuable. However, call options already tend to be priced lower than 澳洲幸运5官方开奖结果体彩网:put-call parity would suggest because of the anticipated dividend in advanc𝐆e - making any excess profits from the strategy minim🙈al if at all existent.

Pros and Cons

Opinion seems to be divided on the wisdom of writing calls on stocks with high dividend yields. Some option veterans endorse call writing on dividend stocks based on the view that it makes sense to generate the maximum possible yield from a portfolio at all times. Others contend that the risk of the stock being "澳洲幸运5官方开奖结果体彩网:called away" isꦰ not worth the measly premiums that may be available from writing calls on a stock with a high dividend yield.

Note that 澳洲幸运5官方开奖结果体彩网:blue-chip stocks that pay relatively high dividends are generally 澳洲幸运5官方开奖结果体彩网:clustered in defensive sectors like telecoms, financials, and utilities. High dividends typically dampen stock price volatility, which in turn leads to lower option premiums. In addition, since a stock generally declines by the dividend amount when it goes 澳洲幸运5官方开奖结果体彩网:ex-dividend, this has the effect ꦺof lowering call premiums and increasing put premiums. The lower premium received from writing calls on high-dividend stocks is offset by the fact that there is a reduced risk of them being called a𓃲way (because they are less volatile).

In general, the covered call strategy works well for stocks that are 澳洲幸运5官方开奖结果体彩网:core holdings in a portfolio, especially during times when the market is trading sideways or is range-bound. It is not particularly appropriate during strong 澳洲幸运5官方开奖结果体彩网:bull markets becꦇause of the el𝔍evated risk of the stocks being called away.

The Bottom Line

Writing calls on stocks with above-average dividends can boost 澳洲幸运5官方开奖结果体彩网:portfolio returns. But, if you believe that the risk of these stocks b🌳eing called is not worth the modest premium received for writing cal💫ls, this strategy may not be for you. Moreover, efficient markets will already price in the dividend in the call option's premium in advance, taking away some of this strategy's attractiveness.