Writing options on these stocks could create income for your portfolio

Investors looking for a way to generate more income now that interest rates appear set to fall can look to wring some extra cash out of their stock portfolio using options. Bank of America derivatives analyst Arjun Goyal this week identified stocks that are strong candidates for an “overwriting” strategy. The trade, also called “call writing,” involves selling a call option on a stock that an investor already owns and is effectively a bet that the stock won’t rise too much before the contract expires. “The strategy is best suited for names the call seller has a neutral short-term view on, as a call sells the right to upside participation beyond the call strike for a fee. Covered call writing is not a hedge and maintains full downside risk,” Goyal’s note said. A call option is a derivatives contract that gives the holder the right to buy a stock at a pre-set strike price. Selling the call option, or “writing,” creates up-front income in the form of the premium paid for the contract, but it limits the potential upside from the underlying stock. Covered call strategies have boomed in popularity over the past few years, in part because of the 2022 market decline followed by a bull market with relatively low volatility, historically speaking. Funds that use covered calls or similar strategies, such as JPMorgan’s Equity Premium Income ETF (JEPI) , have also seen strong interest from investors. “While covered call strategies can underperform stocks in fast bull markets, they can still realize significant profits. Covered call strategies tend to outperform outright stock ownership in flat, down, and slightly up markets,” the Bank of America note said. Trade ideas To find overwriting candidates, Bank of America identified call options on stocks in the Russell 1000 index with mid-October expirations that allow at least 7% upside and have a minimum premium of 5%. Some of the names on the list include car rental company Avis , retailer Dick’s Sporting Goods and health care name in Neurocrine Biosciences . The market price of options can change rapidly, particularly around corporate events like earnings. Dick’s Sporting Goods, for example, is set to report its latest results on Sept. 4. “While we believe that the overwriting candidates … are liquid and appropriate for covered call writing, the premiums noted can change rapidly and adversely. Investors should consider these factors before executing a transaction,” the Bank of America note said. Extending the trade It is important to note that while some options contracts can be be exercised before their expiration, that mechanism is not automatic. If a stock price is closing in or surpassing the strike price, and an investor does not want to have their actual stock “called away,” there are ways to avoid it. The easiest way is to offset this potential by buying a call with the same details as were written previously, effectively canceling out the position. To reduce the cost of buying that call option, an investor could also “roll out” their covered call position by selling another option with a later expiration date, or “roll up” the position by selling a call option with the same expiration but a higher strike price, according to Bank of America. Depending on the option market pricing around any given stock and the strike price chosen, using the “roll out” idea could actually result in additional premium earned on the trade. — CNBC’s Michael Bloom contributed reporting.