(Barrons: Steven M. Sears)
Most people are rational in their nonfinancial lives. They don’t believe in leprechauns or expect to throw a football like Tom Brady, write poetry like T.S. Eliot, sing like Nina Simone, or cook like Alain Ducasse.
Yet many of those same people are outrageously delusional about the markets. They try to constantly maximize profits while ignoring powerful forces that are within their control, like dividends and compound returns. Dividends, after all, account for about 45% of historical stock returns.
These investors are so intent on “top ticking” their investments that they routinely buy high and sell low even though they are intent on the opposite.
The overconfidence extends to predicting how stocks will react to corporate earnings reports to gaming interest-rate hikes. The more nuanced the event or theme, the higher the conviction.
All this is on parade during earnings season, and it always kicks into high gear ahead of Federal Reserve meetings like the one that concludes on Feb. 1.
Rather than speculating on what are often toss-of-the-coin outcomes for all but a very few sophisticated practitioners or trying to game what is opaque to many and beyond the control of most, investors are better served by focusing on financial facts that are made truer by time.
We have endorsed this theme quite regularly and do so again in protest of the palavering that is increasingly passed off as thoughtful analysis. This approach seems particularly relevant at a time when rates are rising and equity returns might not be as easy to achieve, given the competition from bond markets.
We have discussed portfolio hedging, cash-secured put sales, and using options as stock proxies many times, and we return once more to the humble covered call.
The strategy is something that every stock investor can use in their portfolio. The trade involves nothing more complex than selling a call option with a strike price that is above the price of an associated stock that an investor owns.
The covered call is usually created with calls that expire in one to three months. The goal is to enhance a stock’s return. You can think of the money received for selling calls as a “conditional dividend.” What’s the condition of the dividend? You must be willing to sell the stock at a higher price.
Consider C.H. Robinson Worldwide CHRW +0.71% (ticker: CHRW). The freight transportation and logistics specialist was just added to the S&P 500 Dividend Aristocrats IndexSP50DIV –0.08% , which comprises companies that have increased dividends each year for 25 years or more.
With C.H. Robinson stock at $96.84, investors could sell the March $105 call for about $1.50. Should the stock price remain below the strike price, investors keep the call premium, which compares favorably to the stock’s most recent quarterly dividend of 61 cents.
Should the stock be above the strike at expiration, investors are obligated to sell the stock at an effective price of $106.50 (strike price plus premium received). The call also can be adjusted before expiration to avoid assignment.
There are tax consequences to the strategy if it’s used in a taxable account, but paying taxes comes with the territory.
Simple investment strategies aren’t exciting, and that’s OK. Good investing is the practice of repeatable, unemotional, effective discipline. If you can use options strategies to reinforce the habits of good investing—buying low, selling higher, generating income, and reducing risk—you have achieved something worthwhile.
Steven M. Sears is the president and chief operating officer of Options Solutions, a
specialized asset-management firm. Neither he nor the firm has a position in the options
or underlying securities mentioned in this column.