Getting Defensive: 7 Blue Chip Stocks With 7 Buy-Write Option Ideas

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 |  Includes: ABT, CL, JNJ, MDLZ, MRK, PEP, PG, SPY, XLP, XLV
by: Option Maestro

Today I will write about five stocks which I am rotating into that will allow me to get a little more defensive but still participate in this market. As stated in a recent article How to Hedge With Vertical Put Spreads I believe we are long overdue for a slight pull back. But the stocks I will cover today have already corrected and are undervalued in my opinion. In this article I will explain how I am buying into these already beaten up stocks for a bigger discount with options.

I plan on purchasing the shares of blue chip companies and selling covered calls, allowing me to get into these shares cheaper and allowing me to still clip the coupon at least twice. I will be trimming some of the higher beta names out of my portfolio and replacing them with these seven lower beta stocks. This will allow me to participate if the market continues higher, but if the market happens to correct, my portfolio will likely decline less in value.

Strategy #1
The first blue chip on my list is Merck (NYSE:MRK). The stock has a beta of 0.7 a P/E of 9.52, and yields 4.67%. I would purchase shares here and immediately write July 35 calls (1 call for each 100 shares purchased) against my position. This would lower my cost by about 1.5% and would give me two dividend payments of 38¢ each. Assuming the position gets called away at July expiration, this strategy would return 11.3%.

Strategy #2
The second blue chip on my list is Pepsi (NYSE:PEP). The stock has a beta of 0.53 a P/E of 16.08, and yields 3.05%. I would purchase shares here and immediately write October 67.50 calls against my position. This would lower my cost by about 2% and would give me two dividend payments of 48¢ each. Assuming the position gets called away at October expiration, this strategy would return 10.7%.

Strategy #3
The third stock on my list is Kraft (KFT). The stock has a beta of 0.57 a P/E of 22.18, and yields 3.68%. I would purchase shares here and immediately write September 34 calls against my position. This would lower my cost by about 1.5% and would give me two dividend payments of 29¢ each. Assuming the position gets called away at September expiration, this strategy would return 11.4%.

Strategy #4
The fourth stock on my list is Abbott Labs (NYSE:ABT). The stock has a beta of 0.29 a P/E of 16.04, and yields 4.03%. I would purchase shares here and immediately write August 52.50 calls against my position. This would lower my cost by about 1% and would give me two dividend payments of 44¢ each. Assuming the position gets called away at August expiration, this strategy would return 12.8%.

Strategy #5
The fifth blue chip on my list is Procter & Gamble (NYSE:PG). The stock has a beta of 0.52 a P/E of 16.99, and yields 3.09%. I would purchase shares here and immediately write October 67.50 calls against my position. This would lower my cost by about 1.5% and would give me two dividend payments of 48¢ each. Assuming the position gets called away at October expiration, this strategy would return 11.1%.

Strategy #6
The fifth stock on my list is Colgate-Palmolive (NYSE:CL). The stock has a beta of 0.50 a P/E of 17.92, and yields 3.00%. I would purchase shares here and immediately write August 85 calls against my position. This would lower my cost by about 1.5% and would give me two dividend payments of 53¢ each. Assuming the position gets called away at August expiration, this strategy would return 12.9%.

Strategy #7
The last blue chip on my list is Johnson & Johnson (NYSE:JNJ). The stock has a beta of 0.58 a P/E of 12.73, and yields 3.55%. I would purchase shares here and immediately write October 65 calls against my position. This would lower my cost by about 1.8% and would give me two dividend payments of 54¢ each. Assuming the position gets called away at October expiration this strategy would return 10.4%.

All scenarios above have been stated assuming the position will get called away at expiration. The stocks may sell off further and may not get called away where the position could result in an unrealized loss. The downside cushion or protection is stated where I note it would lower my cost. If I said it would lower my cost by about 1.5%, the stock could sell off or trade lower by an additional 1.5% before the position results in an unrealized loss. I plan on holding some of these securities until I get called away or before I am convinced it is time to purchase higher beta equities again. I will do my best to update my readers with a follow up article or by commenting on this article.

The ideas outlined above are bullish strategies and should not be considered if you think the stock will sell off in the near future. However, if you feel the stock could move higher in the near future, this strategy could yield a nice gain.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

The reason option volumes have surged in the last five years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy that it is essential that broker commissions are low enough to profit from the position.

Disclosure: I am long ABT.