Covered Calls To Keep The Lights On

by: David Jonas

Those of you who have read my first three Seeking Alpha articles are familiar with my system for categorizing companies, for the purpose of establishing covered calls, into "Oatmeal" and "Red Bull." For those of you who haven't read those articles, I'll shamelessly plug them here, here, and here.

In this article I'll address a particular segment of oatmeal companies: Utilities.

Utilities are the corporate equivalent of football's offensive linemen. Both are purveyors of dirty work who ply their trades in obscurity, remaining under the radar as long as they don't screw up. Offensive linemen escape attention until they miss a block or commit a penalty, and utilities make the news only when they raise rates or a gas line explodes. (At least running backs -- the beneficiaries of offensive linemen's lonely labors -- occasionally thank their linemen for enabling their own successes. Imagine Steve Jobs giving props to Pacific Gas & Electric?)

Even the name 'Utility' begs disrespect, as it suggests an unexceptional, fungible commodity that exists merely to be used. (Idea: Just imagine the massive image boost Utilities would get if they rebranded themselves as: Necessities. That could do for Utilities what Kiwi Fruit did for Chinese Gooseberry, or Marilyn Manson for Brian Warner ...)

So why bother investing in this uninspiring, unloved corner of the equity universe? The answer, of course, is: Dividends. Today we'll look at ways to supplement juicy utility dividend yields with a dollop of call option premium.

Screening Criteria

Here are the criteria I used to screen for covered call utility candidates.

  • The shares of the utility must be optionable. This criterion rules out an intriguing German utility called EONGY (OTCPK:EONGY), rated 5 stars by Morningstar and currently yielding over 10%. (Maybe the high frequency freaks will find a way to write covered calls on non-optionable companies ...)
  • The utility must be rated three stars or better by both Morningstar and S&P. I think Morningstar does a great job and I pay close attention to their coverage. S&P, of course, is a wee bit tainted from its part in the 2007 subprime mortgage dust-up (but who am I to question assigning AAA+ to a loan of $1 million to an undocumented pole dancer to purchase a $50,000 house?) But S&P management insists that its equity team is squeaky-clean and competent, so I'm good.

[Besides, beyond Morningstar and S&P are a slew of lesser-known analysts such as one called New Constructs LLC. In October 2010 New Constructs introduced me to A-Power Energy (NASDAQ:APWR), a wind power generation company that had garnered New Constructs' highest 'Very Attractive' rating. Being dazzled by New Contructs' shtick (it claims to employ proprietary forensic analysis that exposes accounting information that is invisible to other analysts, like the powers conveyed by those x-ray specs from my childhood) and by APWR's fundamentals, I took a flier on a few shares. Fast-forward just a few months and -- oops! -- APWR gets exposed as a total fraud, the shares collapse, and trading is suspended. It seems that APWR's executives and New Constructs were the only ones generating any wind. And, in June 2011 New Constructs issued a highly favorable and entertaining report on Research In Motion (RIMM) that describes RIMM as -- I'm not making this up -- "super cheap." Oh well, live and learn.]

  • The utility must not serve South Florida. I'm from South Florida, and have lots of family there, but there's something very wrong about the place. It's not only the unbreathable humidity, constant threat of hurricanes, giant pet-snatching bufo toads and rampant bad manners (New Yorkers are Boy Scouts by comparison - fuggedaboudit). South Florida is a magnet for scoundrels, hucksters, and charlatans -- from Al Capone and Bernard Madoff, to the Bee Gees and Lebron James -- and is the Medicare fraud capital of the world. Then there are the Castro brothers, who remain very pissed off about the Bay of Pigs, and are likely to cook up some unspeakable revenge plan, like dispatching squadrons of zombie boat people to South Beach. And if the Taliban are unseated from Pakistan, they will definitely relocate to South Florida, which will then be subject to CIA drone attacks. Florida Power & Light may be a swell company, but I'm afraid that any business based in South Florida won't be there for very much longer.

Here are the top 15 utilities that passed these criteria along with the annualized yield if assigned and if not assigned:

  • National Grid (NYSE:NGG), 48.27%, 37.75%
  • Suburban Propane Partners (NYSE:SPH), 17.35%,25.67%
  • CenterPoint Energy (NYSE:CNP), 26.37%, 14.58%
  • Sempra Energy (NYSE:SRE), 26.54%,13.07%
  • TECO Energy (NYSE:TE), 21.50%,16.73%
  • American Electric Power (NYSE:AEP), 19.86%, 17.09%
  • AmeriGas Partners (NYSE:APU), 22.92%, 12.92%
  • Entergy (NYSE:ETR), 20.62%, 13.88%
  • Ameren (NYSE:AEE), 15.37%, 17.90%
  • PG & E (NYSE:PCG), 20.88%, 12.04%
  • Public Service Enterprise Grp (NYSE:PEG), 16.41%, 10.61%
  • DTE Energy (NYSE:DTE), 15.69%, 11.30%
  • Constellation Energy Group (NYSE:CEG),12.90%, 13.24%
  • Exelon (NYSE:EXC), 13.66%, 12.09%
  • NextEra (NYSE:NEE), 13.75%, 10.71%

Here is more detail:

(Click to enlarge)


  • Pricing data is as of close of market Friday, September 23.
  • Yield calculations reflect purchasing 200 shares and selling two call contracts on Monday, September 26.
  • Total yield includes three components: Share price appreciation, dividends, and option premium.
  • Yield is after expenses, reflecting the following fee schedule:
    • $6.99 Commission
    • .50 option fee
    • $19.99 assignment fee<
  • Strike prices selected are the first OTM strikes, except for SPH and AEE, which are the last ITM strikes.
  • Option expiration dates are timed to earn two dividends, except for NGG, which pays dividends semi-annually.


  • Utility options are thinly traded in general, which creates a wide bid / ask range and causes "execution risk", i.e. you might not find a buyer for your calls at your limit price.
  • If the world is indeed coming to an end, then utility customers may start burning the bills they've stashed under their mattresses to generate energy, as those bills will be worth more as fuel than as currency. This will adversely affect utility company earnings.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.