While the era of ultra-low interest rates may be coming to an end, the search for yield has become even more crucial. Growing companies such as Microsoft (MSFT) recognize the importance of increasing shareholder returns. So, for this purpose, consider a simple options trade with an MSFT stock-covered call strategy.
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The current dividend yield on the S&P 500 is hovering at an anemic 1.51% as of Friday’s close, which isn’t ideal for yield-driven investors. (You can check the Broad Market Indicators page for the performance of the S&P 500. A link is available at the bottom of each day’s IBD Big Picture column.)
So how do you find an appropriate return in today’s environment? Options can certainly play a role.
MSFT action and covered call
A covered call involves buying 100 shares of the underlying stock and simultaneously selling a call option against those shares.
Selling calls limits the upside but increases the return on the investment in the form of an option premium. The investor keeps the premium generated by selling calls no matter what happens with the stock.
According IBD Stock Check, the MSFT stock ranks second in its group. He is holding a composite score of 97, a EPS Ranking of 91 and one Relative strength rating of 90.
When trading covered call options, most investors write monthly call options against their stocks to make the most of the effects of time decay.
This makes a lot of sense, but also requires a lot of active management. What if we sold annual covered calls for MSFT shares? We’ll take a look.
Target this option
On MSFT stock, an investor could sell a call option expiring June 21, 2024 with a strike price of 360 for approximately $34.40, based on recent trading. Writing covered call options generates $3,440 in premium per contract. The purchase of 100 Microsoft shares will cost approximately $34,380, but the net cost may be reduced by the $3,440 option premium received.
Therefore, we have a potential return of 12.12% annualized, or $3,440 / $30,937) for trading MSFT shares in 333 days. This certainly exceeds the dividend yield of most stocks in today’s market and is certainly much better than the current stock yield of 0.77%.
Covered calls are a fantastic way to generate additional income from a stock holding while providing some downside protection.
Investors should weigh the pros and cons of the stock before initiating a bullish trade like a covered call. Remember that options are risky. Investors can lose 100% of their investment.
This article is for educational purposes only and not a commercial recommendation. Remember to always do your due diligence and consult your financial adviser before making any investment decision.
Gavin McMaster holds 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
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