Apple had an impressive run over the last three months, but will the recent rotation put it on the back burner? Investors who think that Apple stock might trade sideways for a few months could look at selling covered calls on their underlying stock position. This gives you some extra income and reduces your cost basis in the stock.
According to IBD Stock Checkup, Apple ranked No. 2 in its industry group and has a Composite Rating of 88, an EPS Rating of 87 and a Relative Strength Rating of 89.
Apple Stock Strategy: The Covered Call
Apple stock only pays a 0.43% annual yield from its dividends. But savvy investors can, in effect, create their own dividend using covered calls.
A covered call involves buying 100 shares of the underlying stock and simultaneously selling a call option against those shares. If you already own shares, you only need to worry about the amount of calls to buy given your position size.
Selling the calls limits the upside but increases the yield from the investment in the form of option premium.
The investor keeps the premium generated from selling calls no matter what happens with the stock.
When trading covered calls, most investors sell monthly calls against their stock to make the most of the effects of time decay.
That makes a lot of sense but also requires a lot of active management.
What if we sold longer-term covered calls against Apple stock?
Long-Term Covered Calls
On Apple stock, a Dec. 20 call option with a strike price of 245 traded around 12 this morning. That generates $1,200 in premium per contract.
Purchasing 100 shares of Apple stock will cost around $23,400, but you effectively reduce the cost by the $1,200 option premium received.
That turns Apple stock into more than a 5% income play if held the next 157 days, or roughly 12% annualized.
The yield you created just beat the dividend yield for most stocks in the current market and still allows for around $1,100 of capital appreciation if your shares are called away.
Biggest Risk Is Limited Upside
It's important to realize that if Apple stock goes up strongly, that $1,100 capital appreciation plus the $1,200 in premium becomes the cap on your participation.
On the downside, the risk with the trade is that Apple stock falls more than the premium received. In that case you will lose money, but less money than if you bought the stock outright.
Covered calls are a fantastic way to generate extra income from a stock holding while also providing some downside protection.
Investors would need to weigh the pros and cons of the stock before initiating a bullish trade like a covered call.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setup is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
