Investors of all ages and investing experience levels are sure to welcome an additional income stream! When writing call options (i.e., selling call contracts against existing stock shares), the main objective is generating income. If the stock ends up above the call strike price at expiration, then the call is exercised and the trader ends up selling the stock shares. Being “covered” means that the investor has the stock shares in his account to deliver if the shares are “called away” from him.

By using high yield stocks as the underlying investment, we can generate two streams of income in this strategy.

• First, we collect a premium every time that we sell another call option against our stock position.
• Second, we also collect dividends on our stock position, typically on a quarterly basis.

These two streams of income are even more impressive when you consider the fact that bonds are currently offering very little value (low yields) to investors.

By utilizing this dual income strategy, we have the potential to consistently generate income. To be more specific, our goal is to generate income on a monthly basis in the covered calls. With this dual income strategy, we have the potential to generate 16 different pieces of income per year (monthly for the covered calls and quarterly for the dividends). Selling one covered call per month = 12 credits annually. Collecting a dividend every three months = 4 credits annually.

For example:

Statoil (STO) currently trades around $17.90/share. Statoil engages in exploration, production, transportation, refining and marketing of petroleum in Norway and internationally.

As of this writing, we could sell an April 17th (monthly) at-the-money 17.50 strike call that expires in about one month. At current prices, this will generate +0.80 (or +$80.00) per call option sold. Based on the $17.90/share price, this is a true income of about +2.3% of the stock value for selling an option.

Remember, 0.40 (17.90 stock price – 17.50 strike price) of the option income is “intrinsic value” and is a return of capital. The true income is the 0.40 of “extrinsic value” or “time value” received. So, that’s +2.3% (0.40 true income / 17.10 cost basis) of income received in just one month’s time!

The obligation in writing each covered call is to deliver 100 shares of STO stock at April expiration for $17.50/share. However, if that happens, then we get to keep the $80.00 per call option sold of income no matter what! If the stock is at $17.50/share or lower at option expiration, then the call expires worthless, we keep our stock and we have made the “true value” of $40.00 of income per call option sold.

Now, what if the stock is below $17.50/share and we end up retaining the shares?

The true risk to this strategy is the share price. If the stock falls sharply in the months/years ahead, then you could be constantly “swimming upstream” and it would be difficult to get ahead. However, if there is a “fundamental” belief that the shares will be stable to higher in the future, then this strategy can be a solid one!

Statoil pays a forward annual dividend yield of 5.8%. This is way more income than the yield on a 10-year Treasury bond (now around 2.0% annually). Now, it is too aggressive to assume that we can annualize the covered call income above (i.e., +2.3% per month x 12 months per year = +27.6% return annually). However, if we can make even a fraction of that annualized covered call income every year plus the 5.8% annual dividend yield, then as long as the stock is stable, this dual income strategy really can be a home run for investors!