Unlocking the Secrets of Covered Call Writing with Verizon: A Simple Guide

Looking for a conservative way to milk extra money from your stocks?

Oct 19, 2024

Milking $$ from your portfolio, source: Bing Image Creator

Are you curious about how to milk extra money from your portfolio with stocks and options? Well, today we’re looking into the world of covered call writing, using Verizon (VZ) as our example. Don’t worry; there’s nothing complicated here. We’ll keep it simple and light!

What is Covered Call Writing?

Imagine you own a lemonade stand, and you have 500 cups of delicious lemonade (just like you own 500 shares of Verizon). Now, what if you let someone pay you to reserve some lemonade for a future date? That’s essentially what covered call writing is! You own the stock (the lemonade), and you sell someone the right to buy it from you at a specific price for a certain amount of time.

Why Use Verizon (VZ)?

Verizon is a giant in the telecommunications world, offering services like phone plans and internet. Plus, they often pay dividends, which is like getting a bonus for owning their stock! So, let’s see how we can make money with a covered call on Verizon.

The Setup: Buying Verizon Shares

Imagine you buy 500 shares of Verizon stock at $43 each. That means you’ve spent $21,500 (500 shares x $43). Now, if you buy your shares before the ex-dividend date, you’ll earn a quarterly dividend of $0.6775 per share. Let’s break down the money you can make from this investment.

Dividends: The Sweet Bonus

Dividends are payments made to shareholders from a company's profits. So if you own 500 shares and Verizon pays a dividend of $0.6775, you would earn:

500 x 0.6775 = $338.75

Cha-ching! That’s a nice bonus for just holding onto your shares.

Selling a Covered Call

Now, let’s say you decide to sell a covered call option with a strike price of $45. This means you’re giving someone the right to buy your shares for $45 each, but only until the option expires. You might receive a premium for selling this option—let’s say $1.00 per share.

Option Premiums: Your Paycheck for Waiting

The premium is what you earn for selling the option. If you sold a covered call for $1.00 per share, here’s how much you’d make:

500 x 1.00 = $500

So now you’ve made $500 just for waiting around and letting someone reserve your lemonade!

What Happens When the Option Expires?

Now, let’s explore the possible outcomes when the option expires. We’ll cover three scenarios:

1. The Stock is Below the Strike Price

2. The Stock is Exactly at the Strike Price

3. The Stock is Above the Strike Price

1. The Stock is Below the Strike Price

Let’s say that when the option expires, Verizon’s stock price is $44. Since it’s below the $45 strike price, the buyer won’t exercise the option. You keep your shares, the $500 premium, and the dividend of $338.75.

Total earnings:

$500 + $338.75 = $838.75

And guess what? You can rinse and repeat this trade!

2. The Stock is Exactly at the Strike Price

If Verizon’s stock is exactly $45 when the option expires, the buyer might choose to exercise the option. You will sell your shares at $45 each, but you still keep the $500 premium and the dividend.

Here’s how the math works out:

You sell 500 shares at $45: 500 x 45 = $22,500
Plus the premium you earned: $500
Plus the dividend: $338.75

Total earnings: $22,500 + $500 + $338.75 = $23,338.75

And since you bought the shares for $21,500, that’s a capital gain of:

$22,500 -21,500 = $1,000

3. The Stock is Above the Strike Price

Now, let’s say the stock is soaring at $48 when the option expires. The buyer will exercise the option, and you’ll sell your shares for $45 each.

You still keep the premium and dividend:

Sale of shares: 500 x 45 = $22,500
Plus the premium: $500
Plus the dividend: $338.75

Total earnings: $22,500 + $500 + $338.75 = $23,338.75

Your capital gain here is: $22,500 - $21,500 = $1,000

But here’s the twist: while you made a profit, you could have sold those shares at $48! So, while you still made money, you missed out on that extra cash. Don’t forget, however, you did make the $1000 capital gain and you already collected the $500 premium plus the $338.75 dividend, so not such a big difference in outcomes here, after all.

Why Choose Short-Term Options?

We usually choose options that expire in less than a month. This helps reduce the volatility and enhances the chance of keeping our stock while also earning dividends and premiums. It’s like trying to grab a snack before dinner; you want to make sure you don’t spoil your appetite!

Your Takeaway

Covered call writing can be a fun and profitable way to earn income from your stocks. With Verizon as our example, you can collect dividends, earn premiums, and potentially earn a capital gain. Just remember the three scenarios when the option expires: below the strike price, at the strike price, or above it.

So, go ahead and consider covered calls for your investment strategy! It’s the most conservative option strategy out there. And, who knows? You might just be the lemonade stand tycoon of the stock market!

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Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.

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