example portfolio 28, Example Portfolio

What is a good example portfolio of covered call investments?

We are asked that question all the time. And although we are not in the business of making specific trade recommendations, the methodology of constructing a diversified portfolio of covered calls can be a useful example. (And if you need a simple example of a covered call, please see Covered Calls Example in the Tutorial.)

The basic concept is to have a variety of holdings in different sectors and pay attention to your position sizing.

You want dividend paying companies if possible. You want to take as little earnings risk as possible. You want position sizing to be reasonable given your account size. And each investment can't be too small or else the commissions and spreads will eat into your returns.

Example Portfolio Research

First, make a list of diversified sectors and come up with a few candidate stocks that you like in each one. Perhaps these:

Sector Representative Stocks
Basic Materials BP, GLD, SLV, XOM
Consumer MCD, KO, PEP
Financial BAC, C, JPM, XLF
Healthcare JNJ, MRK, PFE
Industrials CAT, CMI
Services HOT, T, VZ
Technology AAPL, INCT, MSFT

This is not an exhaustive list of sectors, but it's diverse enough to get us started for example purposes. Larger portfolios may want to get more granular and add more sectors (or just make more than one investment per sector). That's fine but keep in mind you are looking for uncorrelated investments where possible.

From the above list you would look at each stock and check for fundamental and technical characterisics, next ex-dividend date, next earnings release date, recent news items, analyst ratings, option premiums available, etc.

$125K Portfolio Example

After doing your own research, here is one possible set of investments you may have settled on. Note that all of these are in the money covered calls, none have earnings release before the Nov 19 expiration, and some have ex-dividend dates before the Nov 19 expiration (the dividends are factored in to the Profit If Flat numbers):

Symbol Stock
Price
Buy Stock
Sell Calls
Capital Profit
If Flat
Annualized Return
If Flat
XOM 81.55 Buy 200 XOM
Sell 2 Nov 80
15852 242 24.9%
MCD 93.34 Buy 200 MCD
Sell 2 Nov 92.50
18300 200 18.3%
JPM 36.75 Buy 500 JPM
Sell 5 Nov 35
17235 265 24.9%
MRK 35.21 Buy 500 MRK
Sell 5 Nov 35
17250 250 23.2%
CMI 102.94 Buy 200 CMI
Sell 2 Nov 95
18788 212 26.5%
HOT 52.13 Buy 400 HOT
Sell 4 Nov 49
19312 288 24.9%
INTC 25.02 Buy 700 INTC
Sell 7 Nov 24
16737 210 21.6%
Total 123474 1667 22.4%

This example portfolio has 7 positions, one from each sector. That should make them relatively uncorrelated, and the position sizes are appropriate for a $125K portfolio. If all of these stocks were unchanged (or even if they went down a little, but stayed above their strike prices) between today and expiration (22 days from now) then you would make $1667 profit, which is a 22.4% annualized return.

Note: The Profit If Flat numbers do not consider transaction costs but, at the same time, the Capital column assumes you are placing market orders to execute the trades (paying the asking price for the stocks, and receiving the bid price for the calls). But in the real world you could place a limit order to split the bid/ask and likely get better fills than suggested above. So the better fills should compensate for the transaction costs.

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