Covered calls can be your best friend in the kind of volatile markets we’ve been experiencing. Whether you view them as dividend enhancers or downside hedges – or you simply believe that no one ever lost money booking a profit – then today’s relatively high VIX and historically low PE ratios can combine for some interesting low-risk high-reward trades.
The following table highlights ten potential trades that – if the respective stock prices remained unchanged through January 19, 2013 – would offer total returns in excess of 12% (with seven of the ten exceeding 15%).
Here’s how to read the table using Caterpillar (CAT) as an example. On Friday December 23, CAT closed at $92.25. You could have sold a January 2013 call with a strike price of $92.50 for $13.35. During the 13 months that you held the position, you would have received a dividend of $1.84. The option premium plus the dividend would result in a total return of 16.47%.
The downside to all these trades, of course, is that nothing is guaranteed. The stocks could drop below the adjusted cost basis (your cost minus the option premium) or they could soar far above your strike price and you’ll make less profit than if you had simply owned the stock and left call-writing to the conservative types like widows and orphans. Investing – like life – is a trade-off. So evaluate these trades as you would any other and never buy a stock just because you can sell the option at a high premium.