Sunday, January 3, 2010

Using Covered Call Strategy to Produce More Income

In Saturday's Wall Street Journal there was an article about older investors writing calls on equity positions to produce more income:

I have never been a fan of this strategy. It works great in steady-to-up market environments - and stock prices are moving in a range or trending higher - but can really be painful when markets move south.

In some ways, writing calls without some sort of downside protection is a little like selling house insurance. If the house stays intact, you pocket the premium, and all seems well. However, if significant damage occurs, and you have to pay out to cover damages, all of the "gains" realized from selling insurance are lost.

There are several areas in the equity markets that still appear to offer reasonable income opportunities without significant downside risk. I would include stocks of regulated utility companies high on this list. Other possibilities would include large integrated oil company stocks (e.g. BP, or Chevron) and consumer staples companies (e.g General Mills). These companies can offer some income as well the potential for growth in the years to come.

I would also not ignore longer intermediate corporate bond alternatives. I realize that interest rates have begun to move higher, but I still do not believe that we are facing significantly higher interest rates for at least a few years.