With markets looking increasingly volatile, investors might get more interested in generating income in a blue chip stock rather than capital gains — especially with a name such as Starbucks.
Rather than spending money on a daily coffee, option traders can actually generate extra income from consumer-oriented stocks via an option trade known as a covered call.
This strategy involves selling call options against a long stock position. Let's use Starbucks as an example.
Suppose you bought 100 shares of Starbucks stock on Tuesday at 74; the total investment would cost around $7,400.
Covered Call Strategy With Starbucks Stock
A June 17-expiration monthly call option with a 75 strike price traded Tuesday around $2.30, generating $230 in premium per contract. So, selling the call option generates an income of 3.2% in just under one month, equaling around 39.1% annualized. That comes in addition to the 2.7% annual dividend yield.
If SBUX closes above 75 on the expiration date, the shares will be called away at 75, leaving the trader with a total profit of $330 (a $100 gain on the shares bought at 74 per share, plus the $230 option premium received).
That equates to a 4.9% return, which is 59.6% on an annualized basis.
Of course, the risk with the trade is that Starbuck's stock might drop, which could wipe out any gains made from selling the call.
Investors looking to increase their income can use covered calls and cash-secured puts on high dividend stocks.
According to IBD Stock Checkup, SBUX ranks a lowly No. 29 in its group and has a Composite Rating of 33, an EPS Rating of 54 and a Relative Strength Rating of 24.
Please remember that options are risky, and investors can lose 100% of their investment.
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 setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
