How to turn Tesla into a dividend-paying stock

Text size

Being an income investor usually means giving up attractive stocks like

You’re here

And

Nvidia

for a regular payment. But that doesn’t have to be the case, thanks to a set of options known as a “covered call.”

As options trade goes, a covered call is pretty straightforward. A call option gives the holder the right to buy a stock at a fixed price before a predetermined expiration date, while the seller of a call option must deliver stock to the buyer if the stock exceeds the “strike price” specified in the options contract. .

Selling a naked call, that is, selling an option against a stock you don’t own, can be risky. An investor who sold a call option on Nvidia stock (ticker: NVDA) in mid-May with a strike price close to $305 – where it was trading at the time – would have received around $10 per share for selling the option, but they would have had to buy Nvidia stock a few days later for about $400 per share after the chipmaker’s skyrocketing profits to return it to the option holder for $305. That’s a small loss of $75 or, since options contracts are issued in lots of 100, a small sum of $7,500.

A covered call, that is, selling an option against a stock you already own, is much less risky. In our example, a call seller who already owned Nvidia stock would have missed much of the upside, but still pocketed the $10 options premium, effectively selling Nvidia stock for about $315 each.

This is an extreme example, of course. Most stocks don’t typically rise 24% in a day, so selling calls on held positions can be an effective way to generate income without missing out on much potential. After all, most options are never exercised.

This means that even a stock as wild as Tesla (TSLA) could be turned into a source of income. A holder of 1,000 Tesla shares could sell a call option contract, giving the buyer the right to buy 100 shares for $275 each by July 21, up from $270 now. This sale would generate approximately $1,000, or approximately 0.4% of the total portfolio value. Repeat this monthly, and the potential gain is north of 4% per year. Not bad for a stock that doesn’t pay a dividend.

Do the same on 10% of a portfolio holding all seven great stocks – Nvidia, Tesla,

Microsoft

(MSFT),

Apple

(AAPL),

Alphabet

(GOOGL),

Amazon.co.uk

(AMZN), and

Metaplatforms

(META) – could generate an annual gain of around 2%, better than the S&P 500 return of around 1.4%.

The writing of call options increases the risk that an investor’s stock will be “repurchased”. To avoid this,

Active Future Fund
Exchange-traded fund (FFND) co-founder Gary Black doesn’t write covered call options on his Tesla position around events like deliveries or quarterly earnings, despite knowing that the stock can experience a particularly large movement. He is a Tesla bull and wants to reduce the risk that he will have to surrender his shares to a call buyer.

A covered call strategy requires investors to think carefully about which strike prices and expiration dates to use. Writing options with higher strike prices reduces the risk of stock discounts, but those options are worth less.

“I usually try to emphasize the importance of finding the right balance…where I still get significant benefits but also a reasonable amount of bonus,” says Susquehanna analyst Christopher Jacobson.

Covered calls are certainly more complicated than buying a fixed, forgettable dividend stock. There are also tax implications. If the option is exercised, it counts towards the selling price of the stock for tax purposes, explains accountant Robert Willens. But if it expires worthless, it’s treated as a short-term capital gain, just like an ordinary dividend would be.

If you’re looking for income, covered calls have you covered.

Write to Al Root at allen.root@dowjones.com