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How I make a 30% return on safe stocks selling covered calls
Covered calls allow you to earn money on a stock position you already own. This article will show you how I'm making a 30% return on Bank of America without the stock having to gain any value. Please note this is just how I do things. Every trader has different objectives and risk tolerance. Never follow a strategy blindly and always do your own homework.
Covered calls, but aren't they bearish?
Covered calls can be a confusing topic. You are essentially betting that a stock will not go above a given strike price by expiration. Seems bearish right? Or at best neutral. A covered call is a bearish bet if all you cover it with is a further OTM call. In that case you only make money if the stock stays below your strike. This is a credit spread, or bear call spread. Your broker is allowing your long call to "cover" your short position but you will lose money if the stock goes above your strike + premium collected.
However as soon as you add shares to cover the call instead of options you really no longer want the stock to go down. If the stock goes down, sure your covered call will gain value but you're losing money on shares. You would prefer the stock goes right up to the strike and stops just shy of it by expiration. You keep your shares and the premium.
My strategy uses a covered call and therefore a more bullish bet on the stock. You may want to use bear call spreads if you are more bearish on a stock.
Bank of America covered calls
First lets look at the last year's performance of BAC stock. We can see from the image below it started around $40 / share 1 year ago and is currently right around that same level. Seems like a terrible investment aside from the 2% dividend. So how are we going to make a 30% return on this stock?
My strategy for selling calls
The basic outline for my strategy is
- Sell a weekly (or bi-weekly) call that will yield an ROI / Year in my target range.
- Set a stop order to buy more shares at the sold call strike price. This will backfill any shares I lose from assignment. This step is optional if you are happy with the ROI the covered call brings you alone.
- If my stop is hit then sell calls against the new shares.
One negative for selling covered calls close to the current stock price is if I'm assigned then I lose my shares. My strategy accounts for that by backfilling shares at my strike if the stock hits my strike price. I only deal with short expirations to avoid large swings in the stock. It's certainly not perfect and news can drop any time on any day to screw things up. But that's true of any market strategy.
Taxes
Yes there are tax consequences for moving in and out of positions. I'm not terribly concerned about the tax implications because at some point I'll be selling the shares anyway (hopefully for a profit) and I'll have to pay the taxes then. The major difference is long term vs short term tax rates. Again it may be an issue for you and it may not given the much higher gain vs the stock value without covered calls.
If you don't want to deal with this in a taxable account consider it in an IRA where you don't have to worry about taxes on your gains like you would in a Robinhood type account.
Picking the right stocks
This is the more difficult part of the process. I want a stock that meets the following conditions:
- The stock is in an uptrend or at least moving sideways. The current price should be above all of it's moving averages (150 day SMA, 50 day SMA, 21 EMA) and all of those trendlines should be moving up. I know BAC doesn't meet that condition right now and I'm considering moving to other stocks when I get assigned.
- The stock is relatively low volatility. Some volatility is needed to make the option premium worth it but I don't want something that swings huge amounts day to day. The point of this strategy is to make money safely without losing sleep.
- Using the Symbol Search I can find an ROI / Year that makes sense for my goals.
- The stock is priced so I can buy more shares if the strike is going to get hit. I want to be able to backfill my shares.
- I would own this stock outright even without selling calls. It's much easier to do this on a stock I believe in long term.
Keeping track of it all
I keep track of all my option trades in the Option Tracker here on optionsellerroi.com. Using the option tracker you can see your expected ROI, actual ROI and monitor the trade status in real time. It's a free tool that will really help you get the most out of your option selling progress.
The final ROI and expected ROI can be different based on when you close the trade. If I buy back a call that gained value quickly then the ROI / Year would be much higher than a call that goes all the way to expiration.
Wrap up
So as you can see if you are consistent and methodical about your approach, selling calls can be very profitable. Yes there is risk involved, but that's the stock market. There will always be risk and how you manage it is important. I've learned growth stocks can be a double edged sword. They are great on the way up and can crush you on the way down. Selling covered calls on stable stocks that I trust is a much better strategy to outsized returns.