Dividend Capture using Covered Calls

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The 3 Best Covered Calls on Blue-Chip Stocks

Here’s how you can generate blue-chip income without relying on dividends

Don’t assume that if you are a retired or income or conservative investor that you don’t need to have an interest in options. Indeed, selling covered calls can generate income while providing extra padding to your wallet with little risk.

Covered calls are one of the strategies my stock advisory newsletter, The Liberty Portfolio, uses to reduce overall investment risk and generate extra income. With the best covered calls, you own a certain stock, or you buy it for the purpose of selling covered calls, and just use covered calls to make a little more money off of them in exchange for possibly selling earlier than you normally might.

With covered calls you are selling the right for someone else to buy a stock from you at a certain price (strike price), on or before a specific day (expiration date).

You do this because you believe the stock won’t trade above the strike price before expiration. If that stock does not close above that strike price before expiration for more than a couple of days, or does not close above that strike price on expiration, you both keep the money that you were paid for selling the contract, and also keep the stock.

However, if the stock closes above the strike price on expiration, you will have to sell it at the strike price but you will still keep the premium.

Here’s a way to generate income for the next month using covered calls on three blue-chip stocks.

Best Covered Calls: McDonald’s Stock

McDonald’s Corporation (NYSE:MCD) has made quite a turnaround under its new CEO. I think MCD has good times ahead of it so owning McDonald’s stock is probably not a bad move for a long-term diversified portfolio.

We’ve just been through a small market correction, and if MCD stock falls further, and you sell covered calls and the stock falls, you are likely getting it at a better price.

Even if McDonald’s stock gets called away, and you buy back in, and then it falls again, I would not panic. That just means you can buy in at a lower price and average down. MCD will do well over the long term.

MCD closed at $160 on Wednesday. You could sell the 23 March $160 covered calls for $3.55 at last check. You get a 2.22% premium and keep it if it isn’t called away.

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Or you could sell the 20 April $160 covered calls for $4.75, enjoy an almost 3% return, and have a nice little bit of income to the tune of $4.75, as well as earn $1.01 from its next dividend payment.

Best Covered Calls: Berkshire Stock

Berkshire Hathaway Inc. (NYSE:BRK.B, NYSE:BRK.A) also has options available, but only for the B shares. I doubt very many people have 100 shares for a single options contract on the A shares, after all.

Berkshire stock may be the perfect stock for covered calls. The premiums aren’t gigantic, but if the stock isn’t called away, then that premium you just sold could be thought of as a dividend. Remember, Berkshire stock doesn’t pay dividends. You can even generate dividend-like returns in the high single digits each year using covered calls.

So, if BRK does get called away, buy it back and then perhaps go ahead and sell covered calls again. Over time, this strategy is going to throw off a nice little bit of income, and you may or may not miss some of the upside depending on how often the stock gets called away.

Wednesday saw BRK.B stock end at $200.53. You can sell the 23 March covered calls at the $200 strike. If you elect to sell those covered calls for $5.75, you’ll earn a 2.78% in premium.

Best Covered Calls: Boeing Stock

Boeing Co (NYSE:BA) is a strong candidate for selling covered calls. Boeing stock is a great security because not only does it deal in defense, which is always needed, but also because it is part of an oligopoly.

Thus, should you sell covered calls on BA stock and it is called away, you can buy right back into it and continue holding over time. If BA stock should fall by a substantial amount, I might think of it as another buying opportunity. That’s the idea using blue-chip stocks — you don’t mind owning it.

Boeing is not a volatile stock, so the premiums aren’t terribly large, but you are playing it safe and that’s the point.

On Wednesday, BA stock closed at $345. The 16 March $345 covered calls are selling for $11, which is a 3.2% return.

Dividend Capture

DEFINITION of Dividend Capture

A dividend capture strategy is a timing-oriented investment strategy revolving around the purchase and sale of dividend-paying stocks. Dividend capture is specifically the practice of buying a stock just prior to the ex-dividend date in order to capture the dividend, then selling it immediately after the dividend is paid. The purpose of the two trades is simply to receive the dividend, as opposed to selling at a profit.

What Is A Dividend?

BREAKING DOWN Dividend Capture

Many corporations engage in dividend capture strategies because of the limited amount of tax that they must pay on the dividend income of other corporations. Dividend capture is synonymous with trading dividends. It should be noted that many financial planners frown on this strategy for individual clients; the amount of time, research and trading commissions necessary to do it successfully often offsets any profits received.

Who Benefits from a Dividend Capture Strategy?

Although this strategy makes theoretical sense, after taxes and trading cost, it is far less practical for all but a handful of investors who enjoy certain tax or transaction cost benefits. For the income-oriented investor, this seems a semi-easy method to produce income with little capital loss exposure, as a stock is held for a very short period. However, stock exchanges automatically negatively adjust the stock’s price on the ex-dividend date to reflect the upcoming payout. Thus, this strategy requires precise timing to buy the stock at an appropriate level, hold it for a short time, collect the dividend and sell with little transaction cost. In other words, a lot has to go right to make a buck.

One way to test the viability of the dividend capture strategy: If this were profitable, computer-driven investment strategies would have already exploited this opportunity.

Covered Calls

The covered call is a strategy in options trading whereby call options are written against a holding of the underlying security.

Covered Call (OTM) Construction
Long 100 Shares
Sell 1 Call

Using the covered call option strategy, the investor gets to earn a premium writing calls while at the same time appreciate all benefits of underlying stock ownership, such as dividends and voting rights, unless he is assigned an exercise notice on the written call and is obligated to sell his shares.

However, the profit potential of covered call writing is limited as the investor had, in return for the premium, given up the chance to fully profit from a substantial rise in the price of the underlying asset.

Out-of-the-money Covered Call

This is a covered call strategy where the moderately bullish investor sells out-of-the-money calls against a holding of the underlying shares. The OTM covered call is a popular strategy as the investor gets to collect premium while being able to enjoy capital gains (albeit limited) if the underlying stock rallies.

Limited Profit Potential

In addition to the premium received for writing the call, the OTM covered call strategy’s profit also includes a paper gain if the underlying stock price rises, up to the strike price of the call option sold.

The formula for calculating maximum profit is given below:

  • Max Profit = Premium Received – Purchase Price of Underlying + Strike Price of Short Call – Commissions Paid
  • Max Profit Achieved When Price of Underlying >= Strike Price of Short Call

Unlimited Loss Potential

Potential losses for this strategy can be very large and occurs when the price of the underlying security falls. However, this risk is no different from that which the typical stockowner is exposed to. In fact, the covered call writer’s loss is cushioned slightly by the premiums received for writing the calls.

The formula for calculating loss is given below:

  • Maximum Loss = Unlimited
  • Loss Occurs When Price of Underlying

Breakeven Point(s)

The underlier price at which break-even is achieved for the covered call (otm) position can be calculated using the following formula.

  • Breakeven Point = Purchase Price of Underlying – Premium Received


An options trader purchases 100 shares of XYZ stock trading at $50 in June and writes a JUL 55 out-of-the-money call for $2. So he pays $5000 for the 100 shares of XYZ and receives $200 for writing the call option giving a total investment of $4800.

On expiration date, the stock had rallied to $57. Since the striking price of $55 for the call option is lower than the current trading price, the call is assigned and the writer sells the shares for a $500 profit. This brings his total profit to $700 after factoring in the $200 in premiums received for writing the call.

It is interesting to note that the buyer of the call option in this case has a net profit of zero even though the stock had gone up by 7 points.

However, what happens should the stock price had gone down 7 points to $43 instead? Let’s take a look.

At $43, the call writer will incur a paper loss of $700 for holding the 100 shares of XYZ. However, his loss is offset by the $200 in premiums received so his total loss is $500. In comparison, the call buyer’s loss is limited to the premiums paid which is $200.

Note: While we have covered the use of this strategy with reference to stock options, the covered call (otm) is equally applicable using ETF options, index options as well as options on futures.


For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).


Overall, writing out-of-the-money covered calls is an excellent strategy to use if you are mildly bullish toward the underlying stock as it allows you to earn a premium which also acts as a cushion should the stock price go down. So if you are planning to hold on to the shares anyway and have a target selling price in mind that is not too far off, you should write a covered call.

Similar Strategies

The following strategies are similar to the covered call (otm) in that they are also bullish strategies that have limited profit potential and unlimited risk.

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