In a time where interest rates are on a downward trend, investors are seeking ways to generate additional income with their stock portfolios. One strategy gaining popularity is the use of covered call options, also known as call writing. This approach involves selling call options on stocks that an investor already owns, essentially betting that the stock price will not increase significantly before the option contract expires.
The concept behind covered call strategies is to capitalize on the premium received from selling the call option, while potentially limiting the upside potential of the underlying stock. While this strategy is not designed as a hedging mechanism, it does offer the benefit of generating income in various market conditions. According to Bank of America’s derivatives analyst Arjun Goyal, covered call strategies have shown promising results in flat, down, and slightly up markets.
To identify potential candidates for covered call writing, Bank of America focused on call options with mid-October expirations on stocks in the Russell 1000 index. These options had to offer at least 7% upside potential and a minimum premium of 5%. Some of the stocks that met these criteria included Avis, Dick’s Sporting Goods, and Neurocrine Biosciences.
While covered call strategies can be lucrative, it is essential to recognize the potential risks involved. Market prices for options can fluctuate rapidly, especially around significant corporate events like earnings reports. Investors must also be aware of the possibility of early exercise for options contracts and take necessary precautions to manage their positions effectively.
In scenarios where a stock price is nearing or exceeding the call option’s strike price, investors may choose to adjust their positions to avoid having their shares called away. One commonly used method is to purchase a call option with the same terms as the one previously written, effectively canceling out the initial position. Additionally, investors can opt to “roll out” their covered call position by selling a call with a later expiration date or “roll up” the position by selling a call with a higher strike price.
While covered call strategies offer a means of generating additional income from stock holdings, they require careful consideration and monitoring. Investors should assess their risk tolerance, market conditions, and individual stock positions before implementing covered call strategies. By understanding the underlying principles of call writing and actively managing their positions, investors can potentially enhance their portfolio income while mitigating downside risks.