Bookmark and Share 23, Take Profits With Covered Calls

If you've had a nice gain in a stock position it's good discipline to take a bit off the table from time to time to rebalance your portfolio. Covered calls are a good way to exit a position, or part of a position, by milking it for a bit of extra profit. Just sell short-term at-the-money or in-the-money call options against stock you are preparing to sell anyway, or stock where you may be worried that it has topped out in the short run.

Taking Profits Example

In the last 6 months McDonald's (MCD) has had a 34% gain, from $84 to $103:

MCD Stock Price From Nov 2012, to Apr 2013
Take profits in MCD

Currently trading around 100, now would be a good time to take a slightly defensive position and/or take some profits off the table. Rather than sell the stock outright, sell call options with a strike of 100 instead. You'll get a bit of time premium and probably have your position called away. There is the risk that MCD could drop, and if you're worried about that then you can sell a deeper in-the-money option.

How much should you cover?

If you're conservative, cover all of it. But if you want to take partial profits while leaving yourself room for the rest to run then cover 1/3rd of your position (so if you have 300 shares, sell 1 contract).

How Much Extra Profit Could You Get?

The two most likely candidates for MCD are the options that expire this Friday or next month. With MCD currently at 100.07, here are the at-the-money call bids:

Exp Date Strike Call Bid Annualized
Return
Apr 26 100 0.51 36%
May 18 100 1.38 19%

Yes, the Apr 26 expiration is only 3 days away. It's a short term trade to get an extra 50 cents or so for stock you are planning on selling anyway. The May 18 expiration is just less than a month away, but gives you a bit more premium.

To see more examples of how to increase yield on several fast food stocks, see Super-Size Your Big Mac Dividends: Write Covered Calls on SeekingAlpha.

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