Creating Yield in a Virtual Zero Interest Rate Environment
Using Covered Calls
We are living in an environment where it is virtually impossible
to get yield in the traditional manner. The Federal Reserve has
driven interest rates so low that traditional bank CDs or money
market accounts returns are virtually zero. So how do we create
yield in such an environment? One strategy that all investors can
use is options.
There are two strategies any investor can use to create yield
that far exceeds traditional avenues. These options strategies are
Covered Calls and Writing Puts.
Many years ago, my grandfather owned a couple of
Exxon Mobil (
gas stations in downtown Chicago. He loved the company, and over
the years he accumulated a couple of thousand shares of XOM. Upon
his passing, each of his grandchildren received 200 shares. The
options trader in me immediately went to work managing my newfound
position, and I started selling covered calls.
A covered call is a strategy that consists of owning an
underlying stock and selling an option against the stock. Since a
call option represents 100 shares of the underlying stock, you can
sell one call against each 100 shares of stock you own. Because you
own the stock, your short call position is "covered" by the
A short option position by itself (without the stock) is very
risky, and requires a substantial margin balance. A short call on
stock you own, on the other hand, is a very conservative strategy
that requires no margin.
I would recommend a covered call strategy against virtually any
stock an investor holds. In my mind, it's free money.
Let's dive a bit deeper into this strategy.
As of the close last Friday (June 7), XOM was trading at 91.50
and as an owner of 200 shares, I can sell two calls against my
stock position to create some extra yield. For example, I could
sell two July 92.5 calls for $1.50 each.
If XOM stays below 92.5 by the July expiration, I will collect
$300 total ($1.50 x 100 for each contract)-a yield of 1.6% in just
two months. If I an able to replicate this six times a year, I'll
If XOM rises above 92.5, I will be taken out of my 200 shares by
the owner of the call. However, if that were to happen, I could
simply buy my stock back if I wanted to, and start selling calls
all over again.
Writing puts is a more complex strategy, but when broken down
and understood, this can be a tremendous trading strategy, and a
great way to create yield for all investors.
Let's start with what a put is. A put is a contract between two
parties to exchange an underlying stock, at a specific price, on a
determined date. The buyer of the put has the right to sell the
underlying stock at a set price. The seller of the put has the
obligation to buy the underlying stock at the set price.
If you write a put, you are the seller of the put. This can be
thought of in terms of insurance: you're the insurance agency, and
the buyer of the put is the policy owner. If the owner of the put
decides to exercise his right, you will be required to buy the
stock at the predetermined price. However, as the seller of the put
(the insurance agency), you receive a premium.
Here's an example of this strategy in
, which closed trading last Friday at 442. I feel comfortable
buying AAPL stock at 400 so I would look to sell the July 400 puts
If AAPL stock price stays above 400 on July 20 (when the options
expire), I will collect the $350 premium by selling the put, a
yield of 0.79%. If I did this six times a year, I would create a
yield of 4.74%.
There is risk associated with this trade: if AAPL dropped below
400, I would be required to buy AAPL shares at 400. But as I said
earlier, I am comfortable buying AAPL at 400, which is a 10%
discount to where the stock is currently trading.
This is a strategy many traders/investors use to enter a stock
at a predetermined price. If I feel that AAPL is overvalued at its
current price of 442, but am comfortable buying the stock at 400,
this is a great way to buy the stock at that level if the price
drops. And if it doesn't, I still collect the premium and can
always sell another put later on.
In conclusion, there are countless ways to use options to create
yield. Covered calls should be in every investor's playbook. And
writing puts, which are a bit more risky, is a tremendous strategy
to enter a stock at a good price and create yield.
Your guide to successful
Analyst and Editor of Cabot Options Trader