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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 27, 2012 market close

Summary on selection:

Yesterday I featured a very similar set of stocks, the Top 5 Dow Performers of 2012, I think this a good series to continue in the last of 2012. For this article I've chosen the Top 5 S&P 500 Performers, excluding Sprint(#2) due to its low stock price and Bank of America because it was in yesterday's article. These high gaining stocks paired with the call strategy can produce sustainable income on a portfolio that may be over-extended in the short run. My personal feeling is that Pulte Homes is extremely over done, due to the fact that the housing industry isn't roaring back with a vengeance which is what the stock price would have you believe.

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. These companies aren't exactly the most innovative corporations on the planet and their massive bull runs this year should be a red flag, or at least a sign of caution. Playing it safe by generating income with the call could prove to be a very astute play in the near term.

YTD Performances (at close on 12/27/2012):

PHM: 181.46%

WHR: 118.96%

EXPE: 109.74%

LEN: 94.88%

STX: 94.03%

Most of these stocks, in my view, are over extended. Meaning if you write a call you will be able to profit on a momentum pullback in the underlying. Taking a look at the stocks below, you should notice the massive premiums in the calls. For the speculators out there, these stocks are giving you plenty of room to write a naked call while being far out of the money. The Expedia and Seagate contracts would be my favorites to write to uncovered, they are more than 10% out of the money at the moment.

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.

Pulte Homes (PHM) April 20 call

TickerPHM
Strike20
Exp MonthApril
Stock Price$17.76
Call Bid$0.97
Days to Expiration114
OTM12.61%
Call Yield5.18%
Annualized Call Yield16.59%
Annual Dividend Yield0.97%
Total Annual Yield17.56%

Whirlpool (WHR) January 110 call

TickerWHR
Strike110
Exp MonthJanuary
Stock Price$101.16
Call Bid$0.63
Days to Expiration23
OTM8.74%
Call Yield0.57%
Annualized Call Yield9.10%
Annual Dividend Yield0.63%
Total Annual Yield9.73%

Expedia (EXPE) February 70 call

TickerEXPE
Strike70
Exp MonthFebruary
Stock Price$60.30
Call Bid$1.25
Days to Expiration51
OTM16.09%
Call Yield1.99%
Annualized Call Yield14.24%
Annual Dividend Yield0.86%
Total Annual Yield15.10%

Lennar (LEN) February 41 call

TickerLEN
Strike41
Exp MonthFebruary
Stock Price$38.08
Call Bid$0.97
Days to Expiration51
OTM7.67%
Call Yield2.42%
Annualized Call Yield17.29%
Annual Dividend Yield0.42%
Total Annual Yield17.71%

Seagate Tech (STX) March 35 call

TickerSTX
Strike35
Exp MonthMarch
Stock Price$30.21
Call Bid$0.81
Days to Expiration79
OTM15.86%
Call Yield2.52%
Annualized Call Yield11.62%
Annual Dividend Yield5.00%
Total Annual Yield16.62%
Source: Covered Call Idea: Top 5 S&P 500 Gainers 2012