Setting up a covered call portfolio using securities that generated significant dividend distributions was covered by Ben Branch, professor of finance at the University of Massachusetts, Amherst, in two wonderful articles published in the AAII Journal last year.
The articles ran under the titles “Assembling a Covered Call Portfolio on Dividend-Paying Stocks” (June 2014), and “Managing a Portfolio of Covered Calls” (July 2014) and can be found in the AAII.com archives. This article adds information to the key facts highlighted in Branch’s articles and presents another perspective as to how and why such a covered call portfolio can be constructed and managed.
Covered call writing is a strategy where individual investors can sell options against securities—stocks or exchange-traded funds (ETFs)—they already own to generate monthly cash flow. In its traditional sense, profits can be gleaned both from the sale of the option and from share appreciation if the option selected has a higher value than the current market value of the stock. (For example, an investor buys a stock for $48 and sell the $50 call option; this known as an “out-of-the-money” strike.) If the option selected had a strike price (agreed exercise price) the same as (“at the money”) or less than the current market value (“in the money”), the maximum return would be the time value component of the option premium only.