Now consider if the stock moves higher. When the investor wrote the $275 call, the stock was only at $261.05 so they participate in the upside for nearly $14 before the call is at-the-money. Once the stock reaches $278.85, both the call writer and the investor holding just shares of the stock have made the same amount of money.
If Apple continues to go up even more, say to $285, the call writer will not participate in that additional upside — the writer only benefits from the stock appreciation up to the strike price but no higher. When call options are in the money at expiration, the investor will be forced to sell their shares at the strike price and the call option ceases to exist.
With all of that said, here’s the key point: The covered call generated $3.85 in cash flow on a $261.05 investment, which equals 1.47% over a 56-day period, or just over 9.5% on an annualized basis. Remember, this is in a market where the one-year Treasury is yielding 1.55% — a difference of nearly eight full percentage points.
Bottom Line
It seems investors seeking cash flow are left with little choice. Do they hold on to the equity market at an all-time high? Do they accept the unattractive yields on traditional fixed income securities? Or do they take advantage of the opportunities available in the options market. In our view, any strategy that can generate additional yield and cash flow on current equity holdings in a portfolio, especially at this point in the economic and market cycle, is a smart move.
Nick Griebenow is assistant portfolio manager for Shelton Capital Management’s separate account program utilizing covered call writing.