Income Investing Strategies Highlight Covered Calls and Naked Puts

Income investing strategies that involve selling covered calls and naked puts are far less risky than many investors realize, seasoned trader Bryan Perry told me during a recent interview about how he helps subscribers of his Quick Income Trader service seize those opportunities.

Perry described selling covered calls as a “conservative” approach that carries the “lowest risk of all options strategies,” even though many investors might view options as a highly risky trading strategy. The second prong of his Quick Income Trader service’s strategy is to use naked put options as a way to sell option premium back to the market without needing to buy the underlying stock first, he added.  

“If you sell a covered call and hold onto it, you have a 100 percent chance of making money on that trade,” said Perry, who leads the Cash Machine, Premium Income, Hi-Tech Trader, Quick Income Trader and Instant Income Trader advisory services.

Income Investing Strategies Use Covered Calls to Collect Payouts

The covered-call selling strategy allows an income-focused investor to sell premium against an underlying stock and lets the writer of the option keep 100 percent of the purchaser’s money, said Perry, who worked as a high-yield junk bond broker at Bear Stearns and Lehman Brothers in the 1980s. The sale of covered-call options is the most popular form of generating income from stocks that pay low dividends, he added.

If a stock such as Starbucks (NASDAQ:SBUX) is selling at $70 a share, an income investor who owns the stock can sell covered-call options at $72.50 or $75.00 that expire in two or three months to produce income from the buyer of those options, Perry explained. The owner of 100 shares in such a growth stock could collect premium of $250 to $350, depending on the price of the option paid by the buyer of the covered call, he told me when I interviewed him at the Orlando MoneyShow.

To tap that opportunity, Perry said his Quick Income Trader service is designed to recommend stocks to investors who can benefit from share-price increases, as well as through the selling of covered-call options to collect premium from the underlying stock.

Rather than just rely on quarterly dividend payments that may produce a modest yield of 1.89 percent, as in the case of Starbucks, the selling of covered calls three or four times during a year can generate 10-15 percent in income before even factoring in the share price change, Perry said.

Underlying Shares of Covered-Call Trades May Fuel Strong Returns

In several trades so far in 2019, Perry recommended covered-call options that were called away to produce double-digit-percentage returns for Quick Income Trader subscribers. A covered-call option can be called away by the purchaser of the option when the stock price rises above the strike price and the seller of the option is required to sell the shares at the strike price, even when the market value rises above that mark.

In less than two months, information security company CyberArk (NASDAQ: CYBR) covered-call options that were called away on April 18 produced a 21.57 percent return. That return came from the sale of the underlying shares at a higher price than when they were purchased.

In addition, mobile satellite services provider Iridium Communications (NASDAQ:IRDM) covered-call options led the underlying shares to be called away to generate a 26.70 percent return. A 19.52 percent return was achieved when Zendesk, Inc. (NYSE:ZEN) shares were called away in February from a covered-call trade begun the previous September.

Income Investing Strategies Use Naked Puts to Sell Premium

Naked puts offer a way to sell option premium back to the market but there is no need to buy the stock first, Perry said. For example, if Starbucks is trading for $70 and an investor wants to gain income, he or she can sell a Starbucks $70 put to collect money immediately from the buyer of the option.

Perry recommended Starbucks’ April 28 $77.50 puts in his Quick Income Trader service for a transaction in March that produced a 76.95 percent return by April 15. Other hefty recent returns included the World Wrestling Entertainment (NYSE:WWE) April 18 $90 puts that produced a gain of 98.70 percent in less than two months, while the recommendation of the Symantec Corporation (NASDAQ:SYMC) April 18 $25 puts led to a 66.00 percent gain in about six weeks.

An investor can sell a naked put against the market to produce income on the expectation that the stock will rise. If the stock does not rise and falls below the $70 strike price, the investor who sold the naked put would need to buy the stock on the open market and deliver it to the acquirer for the $70 price per share.

“You have to be willing to sell puts on companies you don’t mind owning because of the quality of the company,” Perry said.

An investor also would need to have cash to buy the shares if the stock’s share price fell below the strike price and the option was exercised by the buyer. For an investor who trades through an IRA, the cash to purchase the stock would need to be on reserve, Perry said.

Best Income Investing Strategies with Covered Calls and Naked Puts

The best strategies for investing in covered calls and naked puts right now feature trades in social media company Twitter (TWTR) and cloud security solutions provider Zscaler Inc. (ZS), Perry told me.

One trade Perry likes is to sell the TWTR June 21 $40 calls, while also selling the naked TWTR June 21 $40 puts against the market to obtain immediate income.

Another combination trade Perry proposed to me is to sell the Zscaler Inc. (ZS) June 21 $90 Calls in addition to selling the Zscaler June 21 $90 puts against the market to obtain income.

Income Investing Strategies Are Aimed at Enhancing Returns

The covered-call selling strategy works best for income-seeking investors looking to “enhance their returns,” said Hilary Kramer, a Wall Street money manager who leads the Value Authority, GameChangers, Turbo Trader , High Octane Trader and Inner Circle advisory services for individual investors. For instance, utilities have had a big run recently, and have high price-to-earnings (P/E) ratios and low dividend yields by historical standards.

“The Sector SPDR Utility ETF trades at $59.83 and yields are 2.9 percent, Kramer said. “You could capture the June and September dividends — they are paid quarterly — and enhance your yield by another 2.4 percent by selling September $60 calls, currently trading at $1.45, against your position. This eliminates practically all capital gain upside, but you will get 2 dividends worth 1.5 percent of your investment and roughly 2.4 percent from the option, giving a total yield of 3.9 percent for your investment — not bad for a four-month time period. You are still exposed to capital losses against your XLU holding. You could buy $58 puts to limit this, but it would take away more than 50 percent of pure option income.”

As for naked puts, Kramer said they probably should not be bought unless an index or individual stock is showing signs of breaking down technically. Plus, if a stock’s chart steadies or improves, the seller of a naked put should look to exit that trade, she added.

For investors who seek extra income and do not mind delving into options, selling covered calls and naked puts offer viable income investing strategies for those who can accept some risk. Even though the risk of these options strategies may be limited compared to alternative options, it still exists.

Paul Dykewicz, www.pauldykewicz.com, is an accomplished, award-winning journalist who has written for Dow Jones, the Wall Street Journal, Investor’s Business Daily, USA Today, the Journal of Commerce, Seeking Alpha, GuruFocus and other publications and websites. Paul is the editor of StockInvestor.com and DividendInvestor.com, a writer for both websites and a columnist. He further is the editorial director of Eagle Financial Publications in Washington, D.C., where he edits monthly investment newsletters, time-sensitive trading alerts, free e-letters and other investment reports. Paul previously served as business editor of Baltimore’s Daily Record newspaper. Paul also is the author of an inspirational book, “Holy Smokes! Golden Guidance from Notre Dame’s Championship Chaplain,” with a foreword by former national championship-winning football coach Lou Holtz. Follow Paul on Twitter @PaulDykewicz.