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In the endless search for yield, a covered-call strategy can be an effective tool to supplement portfolio performance. In addition to finding returns from call premium, I'll try to incorporate higher quality dividend stocks for a little something extra. The guidelines for the covered-call strategy are:

  • Generating more than 7% per year from the calls and dividends combined is the overall goal.

  • Call should be at least 8% out of the money (OTM) to avoid being called away and to give room for underlying movement.

  • Targeted expirations will be within four months. Optimally, calls will be written on the same underlying stock 3-4 times per year.

  • Buying back calls to close before expirations takes place will be taken into account; yields are calculated bid-$0.05.

The picks should be looked upon as yield generators to supplement longer-term equity holdings. The above are only guidelines, however, not rules. Before utilizing the strategy, make sure to study it and know the potential hiccups that may occur.

Annualized Call Yield performance can be calculated as such:

= (Call premium - 0.05 /Stock price)/Days to expiration*365

Prices current as of December 26, 2012 market close

Summary on selection:

I've been touting high quality stocks all year, especially on the DJIA. I've come up with the top 5 performers on the Dow index in 2012 and think it's a great list to target for covered calls. The nature of these higher quality stocks paired with the call strategy can produce sustainable income in a portfolio centered on low risk. The only major outlier in this group is Bank of America ML; after being demolished in previous years it has started to make a comeback and may be viewed as the riskiest of the bunch.

It's my personal opinion that none of these are going to be run-away bulls (think Apple (NASDAQ:AAPL)) and that the possibility of capping your returns with the call is a logical bet. The first half of 2013 will most likely be filled with market consolidation and possible weakness; this is a great time to write calls on stocks which have had massive runs.

YTD Performances (at close on 12/26/2012):

BAC: 108.68%

HD: 48.61%

JPM: 36.14%

DIS: 34.99%

TRV: 25.64%

Listing the top performers is a great place to start with these lists. Most of these stocks are probably over extended, meaning if you write a call you will be able to profit on a momentum pullback in the underlying. I particularly like to utilize the covered call strategy on stocks that have had big run-ups and then slowed down in the face of immediate future volatility (fiscal cliff).

The tried and true advice of "stick to the basics" is more and more relevant in today's turbulent markets. As always I'm not recommending equity buys and sells, I'm spotlighting calls to help generate income.

Bank of America ML (BAC) March 13 call

Exp MonthMarch
Stock Price$11.54
Call Bid$0.30
Days to Expiration80
Call Yield2.17%
Annualized Call Yield9.88%
Annual Dividend Yield0.40%
Total Annual Yield10.28%

Home Depot (HD) February 65 call

Exp MonthFebruary
Stock Price$61.14
Call Bid$0.61
Days to Expiration52
Call Yield0.92%
Annualized Call Yield6.43%
Annual Dividend Yield1.90%
Total Annual Yield8.33%

JP Morgan (JPM) February 47 call

Exp MonthFebruary
Stock Price$43.96
Call Bid$0.46
Days to Expiration52
Call Yield0.93%
Annualized Call Yield6.55%
Annual Dividend Yield2.70%
Total Annual Yield9.25%

Disney (DIS) April 52.5 call

Exp MonthApril
Stock Price$49.85
Call Bid$1.25
Days to Expiration115
Call Yield2.41%
Annualized Call Yield7.64%
Annual Dividend Yield1.50%
Total Annual Yield9.14%

Travelers Companies (TRV) March 77.5 call

Exp MonthMarch
Stock Price$72.27
Call Bid$0.50
Days to Expiration80
Call Yield0.62%
Annualized Call Yield2.84%
Annual Dividend Yield2.50%
Total Annual Yield5.34%

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.