The Benefits Of Using Covered Calls

| November 6, 2015 | 0 Comments

covered call strategyThe Benefits Of Using Covered Calls

Covered calls are an extremely popular yet often misunderstood options strategy.  This strategy is widely used by retail and institutional traders alike.  However, I frequently feel the strategy is misrepresented, and sometimes poorly executed.

You see, a covered call strategy seems simple in theory (and it certainly can be).  But, it is a far more nuanced type of trading than many people understand.  If you really want to delve into it, covered call trading can be quite complex.

However, there are plenty of straightforward ways to implement covered calls, without getting too bogged down in the details.  The key is to understand what the benefits are to using a covered call strategy.

Okay, so why use covered calls?

Let’s start by looking at an example.

Here’s the chart of $JNJ:

chart of $JNJ performance for the last year

Is there a more consistent, stable stock than Johnson & Johnson $JNJ?  I’m not sure there is.  It’s been one of the most reliable stocks to own for the last quarter century.

JNJ has grown its dividend for at least 25 straight years.  And it continues to boast strong fundamentals year after year.  There should be no surprise it’s a mainstay in many funds and portfolios.

Looking at JNJ over the last year, it’s been mostly sideways trade.  The stock also recovered pretty quickly after the correction in late August.  Basically, it’s a nearly ideal covered call candidate.

You see, covered calls work best in a neutral or bullish environment for stocks.  Looking at JNJ, it’s either been trading in a neutral or bullish pattern.

So what are the benefits to covered calls? 

Just a quick reminder, a covered call trade is selling a call against a long stock position.  The trade is maximized if the stock price is right at the short call strike upon expiration.  For a refresher on covered calls basics, follow the link.

As great as JNJ has been for most portfolios over the years, it hasn’t been a barn burner this year.  In fact, if you bought the stock at the beginning of the year, you’d only be flat on the year so far.  That’s worse than the overall market has performed in comparison.

However, you could have easily outperformed the market if you were selling covered calls against your JNJ stock this year.

Here’s why…

During JNJ’s sideways period, from roughly February to August, the stock basically traded between $98 and $102.  Over that entire period, you could have sold covered calls at $102 or higher and collected the premium from those calls each and every month.

By collecting premium for the six month period, you probably would have added at least 5% returns (and perhaps quite a bit more) to your stagnant stock position.  And that’s just using the most basic covered call strategy.

Moreover, once the stock dropped during the August correction, you had additional opportunities to profit from covered calls.  Knowing JNJ is a strong, resilient stock with a regular dividend, it wasn’t hard to expect a rebound.

After the market volatility cooled somewhat, you could have sold covered calls against JNJ all the way back up.  It’s very possible you could have collected on the calls and the stock appreciation in that case.  It’s a win-win situation!

And, if you were holding covered calls during the correction, it would have at least offset your loss on the stock somewhat.  While not ideal, it’s still a better overall result than someone who just owned the stock outright.

JNJ is a perfect case study into the benefits of covered calls.  It’s easy to see how you can increase returns in your portfolio by using the strategy with stocks you’re already holding – or even stocks you buy just for the purpose of selling calls against them.  Either way, the benefits far outweigh the detriments.

Yours in Profit,

Gordon Lewis

Note:  Gordon Lewis has been trading options for more than 15 years and he now writes and edits for Optionstradingresearch.com.  You can sign up for the newsletter and get a free research report. We are your go-to source for top notch options trading research.

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Category: Covered Call Writing

About the Author ()

Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also editor of our dynamic theme-based options trading service, Advanced Options Adviser, and one of the key analysts behind the highly successful Options Trading Wire.

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