We've Got You Covered
Peter Katevatis - Jun 30, 2016
Like most financial institutions, the team at Katevatis Wealth Management strives to make their clients feel warm and fuzzy. We aim to match our client’s needs with an appropriate and suitable plan. Dealing with excess capital is a wonderful and
Like most financial institutions, the team at Katevatis Wealth Management strives to make their clients feel warm and fuzzy. We aim to match our client’s needs with an appropriate and suitable plan.
Dealing with excess capital is a wonderful and often daunting experience. Whether this excess comes from proceeds of selling your Vancouver real estate, an inheritance, selling your business, or simply savings… it can be confusing with all the options available to you. Our team can help.
How do you make your capital work for you? You use this capital to generate income.
Generating income is one of the most common needs of our clients. Unfortunately, with low interest rates, it creates an environment with sadly low bond yields. Low bond yields don’t generate a lot of income. One solution is to create a portfolio of dividend paying equities and adding a covered call strategy that can further increase the income.
Today’s markets are ripe with fear and volatility. This fear and volatility can be created by:
- the media;
- financial engineering by central bankers;
- high debt levels from low interest rates;
- or high frequency trading, or more theories that no-one can prove.
Covered call strategies cash in on the market’s fear without having to sell your existing positions. A call option gives the holder, the right (but not the obligation) to buy shares at a set price until a set date. A covered call strategy is an income producing strategy that involves selling calls on shares you already own. Simply put, for the right to buy your shares at a pre-determined price in the future, the buyer will pay you a fee today that is yours to keep regardless if they actually buy the shares in the future or not at the set price by the set date.
Example of a covered call:
- You own 1,000 shares in Royal Bank (currently $78.50) generating $3,240/year in dividends
- You sell an above market price ($80) call option that expires in two months for proceeds of $500
- You then repeat this process five more times throughout the year
- This will now generate $6,240 cash, almost doubling your original yield
Doubling your income and maintaining your existing position seems too good to be true, and sometimes it is - so there is a flip side. There are several negatives to the strategy but the biggest one is that “you are limiting your upside”. If shares of Royal Bank are trading over $80 on option expiry date you miss out on any gains over your sell price of $80.
Another downside to the strategy is the added cost, which makes covered call strategies only feasible for fee-based accounts. A small $500 trade 6 times per year is not suitable for a commission account.
There are other assumptions that I have made in this example with regards to stable volatility (now there’s an oxymoron for you), risk premiums and liquidity. Feel free to contact me to see if this strategy might be something you would consider or if you want more details and a further explanation on how options can help your account grow.