The importance of Velocity in Covered Calls in a Dividend Portfolio
This is a follow-up blog to my newfound respect for a conservative dividend related portfolio, enhanced by an active covered call strategy. A few staring assumptions....
1) You will need enough capital to be able to maintain at least 100 shares of a typical mega-cap dividend paying company. Ideally, you will be managing a porfolio of 4-5 positions of this type. A porfolio of around 40,000 and above can manage this strategy effectively. You will likely need a minimum of approximately 10,000 to 12,000 to do this right.
Since, obviously, you can't write a covered call if you don't have 100 shares in the company, because, um, otherwise, it's not covered.
2) You will need to maintain a watch list of several eligible companies. These companies are familiar names that everyone knows. GE, KO, PG, KMB, JNJ, WMT, MCD The companies should pay a solid dividend and be fairly stable. Ideally, you don't actually want price appreciation to be more than 5-10% per year. This stability will help to avoid having to reallocate called-out positions. You should have at least 4 or 5 more options than number of positions that you are actually managing at any given time.
Now, doing it.....
Now that you're ready to go, you can begin to allocate your positions. Allocate in blocks of 100 shares.....in approximately similar $ blocks. Feel free to more heavily weight a position with a stronger dividend or that you are slightly more bullish on.
Then, write calls against the positions. Only, don't do it as suggested by most covered call strategies that I have seen. Do not take the 3 month call and write against it. You will notice that velocity of call decay is not linear and by writing against the 3 month out call, you are only really getting velocity in 1 month out of three. Yuk. There are points where you can get more bang for your buck. Take the current Kraft call tree
Say you have 200 shares of Kraft that you just bought.
Mar 22 -- 60 = 0
April 29 -- 60 = 0
June 21 -- 60 = .15
Sep 20 -- 60 = .55
You sell two calls against this position for September 20 worth 110. Expect to sell after 4 months, rather than letting it expire. Repeat three times annually. Boom. 330 against 11,000 allocated. You've added 3% to your 3.75% dividend yield and are now yielding 6.75%. After fees, it's closer to 6.5%,
If you get called out, you sit at an annualized return of 15.85%
I literally took the first company off my list and ran it through the process. There are stocks that are slightly more favorably positioned, and you can time things a little better. I literally just took an average stock and put this together. VERY EASY.
The biggest key is you buy calls further into the future than you are usually taught and you sell them a couple of months before they mature. For the last couple of months, these calls are virtually worthless. You are losing valuable velocity with your money by letting them expire. Buy them back for a couple of pennies and reapply your money.