Covered Calls: How To Generate Profits In A Flat Market
Stocks are having an epic first quarter of 2012. The S&P 500 has surged 145 points so far this year. That amounts to an eye-popping 11.5% gain for the large cap index.
No doubt about it, investors are happy to see stocks on the upswing.
But here’s the thing… At the beginning of the year, about 53% of all stock market analysts rated the S&P 500 a buy. Today, only 50% of the analysts think the S&P 500 is a buy.
Clearly, market analysts are becoming more bearish on stocks.
Look, I don’t know many investors who don’t think an 11.5% yearly gain in large cap stocks is outstanding. And we’ve already gotten that this year. Now analyst sentiment is turning more bearish. It wouldn’t be surprising to see stocks flat line the rest of the year.
The good news is there are still plenty of ways to generate profits in a flat market. One of my favorite is covered call writing.
If your portfolio is loaded up with high quality blue chip stocks like Microsoft (MSFT), American Express (AXP), Home Depot (HD), and Walt Disney (DIS), you’re sitting on some tidy profits. So far this year, MSFT is up 24%, AXP is up 21%, HD is up 19%, and DIS is up 15%.
But the reality is, if the entire market isn’t moving higher, then these stocks aren’t likely to be soaring higher either. Some investors may be tempted to sell and look for better opportunities. Instead of selling your stocks, selling call options against your existing stock holdings can generate solid profits. And it could even allow you to sell your stock at a higher price…
For example, DIS is trading for $43.27. If you own 1,000 shares of DIS, you can sell 10 option contracts against your position. Today you can sell the May $44 Calls for $1.15.
The May $44 calls are out-of-the-money calls. The $44 strike price is higher than the $43.27 DIS is currently trading for. As soon as you sell them, you’ll receive $1,150 in option premium ($1.15 per contract x 100 shares per contract x 10 contracts).
If DIS trades above $44 any time before May 19th, your stock will likely be called away. In other words, your shares of DIS will be sold for $44. & But by selling call options instead of just selling the stock today, you’ll make an additional $1,880.
Remember, you get to keep the $1,150 in option premium and you sold 1,000 shares of DIS at $44 instead of $43.27, which nets you an additional $730.
However, if DIS doesn’t reach $44 by May 19th, then the options will expire worthless. You get to keep the $1,150 in option premium and you still own 1,000 shares of DIS.
The best part is you can sell 10 more calls against your DIS position and collect another premium. You can do this over and over again until the shares get called away. In a flat market, you can sell options that expire in a month or two and collect multiple premiums throughout the year.
As you can see, selling out of the money call options against your existing positions can be a great way to generate profits in a flat market.
Category: Options Trading
