IBM, one of the top yielding stocks in the Dow Jones Industrial Average, is in a nice uptrend and is showing improving relative strength.
Investors searching for yield can further enhance the yield on IBM stock by using a covered call strategy.
When selling a covered call, the investor receives a premium but must sell the shares at the strike price if called upon to do so.
One call option contract represents 100 shares, so investors can sell multiple call options if they have a particularly large stock holding.
Strategy Increases Returns, Reduces Portfolio Volatility
Over time, covered calls can increase returns while also decreasing the volatility of a portfolio.
On IBM stock, a January-expiry, 150 call option was trading Tuesday around $3.40, generating $340 in premium per contract and increasing the annualized yield by 17%.
IBM currently pays around $6.60 in annual dividends, so generating another $3.40 from covered call writing in only one and a half months is quite attractive.
The $3.40 in premium received also gives a small buffer on the downside of 2.32%. That means IBM stock could trade 2.32% lower between now and Jan. 20, and the covered call trade would still break-even.
The total capital at risk in the trade would be $14,309, and if IBM stock went to zero, that's how much the trade would lose.
Option Strategy Provides Some Downside Protection
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.
According to the IBD Stock Checkup, IBM stock is ranked No. 7 in its industry group and has a Composite Rating of 82, an EPS Rating of 59 and a Relative Strength Rating of 92.
Please remember that options are risky, and 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
