Why Stock Splits Matter: Covered Calls

by OhioBaseball

Covered calls are when you sell call options against the stock you already own and collect the income from the premium. If the underlying stock rallies above the strike price, you will lose on the call you wrote but if you own the underlying stock you obviously benefit from the appreciation. If taxes are managed appropriately, this is a great strategy for retirees that have very few sources of income in this ultra low interest rate environment. I do this often and you can write deep OTM calls against shares you already own and generate some surprisingly nice income yields. These kids on wallstreetbets are practically fighting among themselves to buy these deep OTM short expiry calls from you. I wrote some calls this week expiring in January 2021 and would need a 40% price appreciation to be exercised and I collected a 2.7% premium on them. These are manufactured dividends and I’m still a very pleased investor if I’m up 40% in the next 5 months should the calls be exercised.

The problem with covered calls is to write 1 option contract you need to own 100 shares. I own a healthy amount of Alphabet, but I would need $150k in the stock just to write 1 option contract against these shares. This is a great company but covered calls just are not an option for me. A stock split solves this problem. For investors that like to have diversification, some of these higher priced stocks keep you away from participating in this great strategy that I believe is even more attractive in this low rate environment.

When you own a stock, I think it is smart to have an exit strategy. If you own AMZN and decide you’ll sell at $4,000/share by the end of the year, why not just write a call with a strike at $4,000 and earn the option premium? You’re not going to get rich but these premiums add up over time. If Amazon does a 10-for-1 stock split, instead of needing $310,000 to do covered calls, all you will need is $31,000 in it to implement this strategy.

I understand the direct impact that a stock split does not matter in terms of creating value, but second and third order impacts will show that they do matter in some respects and covered call writers should applaud them when they occur.

 

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.