By Rick Pendergraft, Editor of Cabot Options Trader
From Cabot Wealth Advisory 1/24/11 Sign up for free Cabot Wealth Advisory e-newsletter
Let’s look at an ETF where investors can enhance their returns by writing covered calls.
The Utilities Select Sector SPDR (XLU) is a somewhat stodgy investment. It doesn’t seem to change greatly in either direction from month to month. Over the last two years, XLU has traded between 22.50 and 32.50. XLU currently yields just over 4% through dividends that it pays throughout the year.
The strategy here is to buy shares of XLU as an income-producing holding for your portfolio and then write covered calls against these shares. If you buy 400 shares of XLU at the current price of 31.80, you can write one, two, three or four calls and still remain covered. I like to write options for half of my holdings, so in this case, I would write two calls. This allows us to keep a portion of the original investment even if the ETF rises sharply and goes above the strike price of the calls we have written.
Because the XLU is so slow and steady with its movement, the option premiums are very low. The current price on the June 33 Call is 0.40 ($40 each). So if we write two calls, we are collecting $80 in premiums and 200 of our 400 shares are at risk of getting called away should the XLU move above the 33 level between now and June.
Let’s look at how this trade scenario could work out. To purchase 400 shares of XLU would cost $12,720 at the current price of 31.80. If XLU rises to 33 between now and June, the return would be 3.7% (roughly $470) plus we would collect approximately 2% (roughly $250) in dividends. This would result in a return of approximately 5.6%. If we add the $80 we get from writing the calls, we’ve made approximately $800 for a return of 6.3%. So we boosted our return by 0.7% over a five-month period! And if none of the shares get called away from us, we can do this again and again. You can add several percentage points to annual returns by writing covered calls.
Editor's note: You can leverage your investments to make money in all markets. Cabot Options Trader Editor Rick Pendergraft uses the market’s volatility to bring his subscribers huge profit-making opportunities. Just check out these gains from the last three months: A 109% gain on a Call on Pride International (PDE) in only 15 days, an 88% gain on a Put on Arcelor Mittal (MIT) in 13 days, a 70% gain on a Call on Linear Technology (LLTC) in 14 day. Click here to join today.