Even though the era of ultralow interest rates is perhaps nearing an end, the search for yield has become even more crucial. Growth companies such as Microsoft (MSFT) recognize the importance of boosting shareholder returns. So to that end, let’s consider a simple option trade with a covered call strategy in MSFT stock.
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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 — hardly ideal for investors who rely on yield. (You can check the General Market Indicators page for the S&P 500’s yield. A link is available at the bottom of each day’s IBD Big Picture column.)
So, how can we find an appropriate yield in the current environment? Options can definitely play a role.
MSFT Stock And The Covered Call
A covered call involves buying 100 shares of the underlying stock and simultaneously selling a call option against those shares.
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.
According to IBD Stock Checkup, MSFT stock ranks No. 2 in its group. It holds a Composite Rating of 97, an EPS Rating of 91 and a Relative Strength Rating of 90.
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 yearly covered calls against MSFT stock? Let’s take a look.
Target This Option
On MSFT stock, an investor could sell a June 21, 2024-expiring call option with a strike price of 360 for around $34.40, based on recent trading. The covered call option sale generates $3,440 in premium per contract. Purchasing 100 shares of Microsoft stock will cost around $34,380, but the net cost can 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 the trade in MSFT stock in 333 days. That sure beats the dividend yield on most stocks in the current market and is certainly a whole lot better than the current stock’s yield of 0.77%.
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. 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 setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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