BERLIN – Analysts may be expecting a relatively flat market through 2008, but that doesn’t mean your portfolio has to stagnate.
A covered-call strategy tends to outperform outright equity investing in bearish, flat and moderately bullish markets (while underperforming in strong bull markets). It can also generate additional income from your equity positions without disrupting your long-term investment approach.
Here’s how a covered call works: In exchange for the premium you receive from writing a covered call, you agree to sell the stock at a specific “strike” price for a fixed period of time. Say you own 100 shares of a stock trading at $35 a share. You might sell a six-month call option contract for a $200 premium ($2 per share) with a strike price of $40. If the stock stays below $40 during that six-month period, you’d keep the $200 premium and your stock position. If the stock drops, the $2 premium will partially offset its depreciation. If the stock price rises above the $40 strike price, you are obliged to sell the stock to the buyer of the contract, sacrificing any upside above $42 (the $40 strike price plus the $2 premium).
If for any reason your market outlook changes before expiration or assignment, you may be able to buy back the call option contract and close out your position.
Income-oriented investors sometimes use covered calls to supplement their dividend income and enhance their portfolio’s yield. And investors with specific target prices often use covered calls to generate income through the premiums; in return, they agree to sell their shares at the strike price of the covered call, if the call owner elects to buy them.
Your financial advisor can run custom covered-call scenarios on a single stock or your entire portfolio. You can base these scenarios on your specific income goals or growth targets, and your financial advisor can provide you with a real-time income analysis and also tell you what the overall returns might be as well as the potential tradeoffs involved in the covered-call strategy.
Ask your financial advisor how they can help you to use covered calls to achieve your investment goals.
(A Merrill Lynch Senior Financial Advisor who can be reached at 410-213-8520.)