In a time where interest rates are expected to fall, investors are constantly seeking ways to boost their income. One strategy that has gained popularity is the use of options to generate additional cash flow from a stock portfolio. By selling call options on stocks that are already owned, investors can implement an “overwriting” strategy that involves betting that the stock price won’t rise significantly before the option expires.
Covered call writing, also known as call writing, consists of selling a call option on a stock that an investor already holds. This strategy is most effective when the investor has a neutral short-term view on the stock. By selling a call option, the investor collects a premium upfront, but also limits the potential upside from the underlying stock. It is important to note that covered call writing is not a hedge and maintains full downside risk.
Covered call strategies have gained popularity in recent years, especially after the market decline of 2022 followed by a relatively low volatility bull market. Funds that utilize covered calls, such as JPMorgan’s Equity Premium Income ETF (JEPI), have attracted strong interest from investors. While covered call strategies may underperform in fast bull markets, they can still yield significant profits and tend to outperform outright stock ownership in flat, down, and slightly up markets.
To identify potential overwriting candidates, Bank of America has flagged call options on stocks within the Russell 1000 index with mid-October expirations that offer at least 7% upside and a minimum premium of 5%. Some of the stocks highlighted in Bank of America’s analysis include Avis, Dick’s Sporting Goods, and Neurocrine Biosciences. However, it is crucial to bear in mind that the market price of options can fluctuate rapidly, particularly around corporate events like earnings releases.
While some options contracts can be exercised before their expiration dates, this is not automatic. Investors who do not wish to have their actual stock “called away” can offset this risk by purchasing a call option with identical terms to the one that was written initially. Additionally, investors can consider “rolling out” their covered call position by selling another option with a later expiration date or “rolling up” the position by selling a call option with a higher strike price. Depending on the pricing of the option market and the chosen strike price, using the “roll out” strategy could result in additional premium earned on the trade.
Utilizing covered call writing can be an effective strategy for investors looking to enhance their income potential from their stock portfolio. However, it is essential to carefully analyze and monitor market conditions, as well as the specific stocks and options being traded. While this strategy can provide additional cash flow and mitigate downside risk, it is not without its complexities and potential drawbacks. Investors should exercise caution and consider seeking advice from financial professionals before engaging in covered call writing strategies.