During his recent interview with Tobias. Tim Travis of T&T Capital Management discusses why ‘covered calls’ are a great strategy for enhancing yield, saying:
Tim Travis: Sure. So, covered calls we use less frequently, but it’s a great strategy to enhance the yield. So, if you have a dividend paying stock, like AT&T for instance, that’d be a dog of the Dow after its poor performance last year. The yield 6%, 6.5% currently, and it trades that are reasonable, multiple … a lot of debt. So, you’ve got to kind of be comfortable that they’re going to pay down that debt. But it’s a stock we do actually like down here. So, you’ve got basically a junk bond yield. We might sell a call, let’s say at $35 or something like that.
I’m not sure what those option prices are currently, but maybe you pick up another 5% premium from selling that call out a year from now. There you’re at 6% on the dividend, 5% on the call. So that’s 11%. And then you have upside from $30 to $35. It can be an attractive way to get a little more yield out of your portfolio if you’re comfortable with that.
Tobias Carlisle: And so, if the stock hits that price, you’ve already … you’ve said, I’ll sell it at that price.
Tim Travis: You’re willing to sell it. Exactly. And that’ll happen. I mean, we’ll sell covered calls and there’ll be stocks we feel really good about. I mean, if we a feel a stock’s worth $60, we’re not going to sell a call at $35. That doesn’t make sense. But if it’s worth $40, maybe. I mean, we want to sell as things converge to intrinsic value. But it’s a learning process. You kind of have to coach your clients, if you’re a financial advisor, or you have to coach yourself to kind of deal with the peculiarities of options.
There can be a pretty big spread between the bid ask, so you’ve got to be cognizant of that sort of thing. Or one of the great things about options is that they provide a lot of protection to your portfolio in the way that we’re using them. But you have to kind of let time do its thing. Time decay is a big deal.
So, if the market’s down 5% tomorrow, we’re going to feel the same hit, even though we have a lot of protection layers. But at the time of option expiration, you get the full benefit of those premiums and that’s where you see the bigger margin of safety.
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