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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 4 months. Optimally calls will be written on the same underlying 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 August 8, 2012 market close

Summary on choices:

Dow names have been chosen here because they tend to have lower betas and decent dividends; the recent equity market uncertainty pushes me to feel these are better portfolio components. The difficulty with choosing stocks like these is the lower beta means lower implied volatility for the option pricing - which makes contract discovery more challenging. Along with that, I like all of these as long-term investments.

Home Depot, Inc. (NYSE:HD) November 55 call

Strike55
Exp MonthNovember
Stock Price$52.79
Call Bid$1.20
Days to Expiration101
OTM4.19%
Call Yield2.18%
Annualized Call Yield7.87%
Annual Dividend Yield2.21%
Total Annual Yield10.08%

Verizon Communications (NYSE:VZ) October 46 call

Great dividend from this stock to work with.

Strike46
Exp MonthOctober
Stock Price$44.18
Call Bid$0.42
Days to Expiration73
OTM4.12%
Call Yield0.84%
Annualized Call Yield4.19%
Annual Dividend Yield4.50%
Total Annual Yield8.69%

International Business Machines Corporation (IBM) October 210 call

The low beta nature of this stock allows us to pick a strike closer to the underlying price.

Strike210
Exp MonthOctober
Stock Price$199.03
Call Bid$1.90
Days to Expiration73
OTM5.51%
Call Yield0.93%
Annualized Call Yield4.65%
Annual Dividend Yield1.70%
Total Annual Yield6.35%

Source: 3 Dow Covered Calls: Home Depot, Verizon, IBM