The hunt for yield is quite difficult in this era.  I still remember my dad telling me about investing in the 80’s when he found a CD that was paying over 10%.  I also remember when I started my first ever passbook savings account and was getting 5.5% interest on that.  Times have changed to say the least.

In today’s environment, it isn’t even worth mentioning what a CD or a savings account would pay.  In fact, if you can get a bank product that doesn’t charge you fees, then you seem to be doing great.  Now, most Americans get their investment growth through stocks as an asset class.

But what about for the money that you don’t want to put at risk in the stock market?  Is there still a place for fixed income in today’s modern portfolio?  I say there is!

I’ve talked many times (probably over 1000 if I were to guess) about the covered call strategy with stocks.  The concept is that you can sell a call option against the stock that you own.  Yes, you do give up potential upside on the stock, but you get the income regardless of how the stock performs.  However, today, I’d like to discuss the concept of the covered call, but the fact that it can be done on a bond ETF.

Bond ETF’s can vary as much as the bonds themselves.  There are quite a few of them.  What I want to show you today is that you can use some of these funds to hold something that is theoretically safer than a stock, and still collect income. 

Let’s say that you want exposure to U.S. Government treasuries.  You can take a look at IEF or TLT (full disclosure, I have client exposure to at least one of these right now).  IEF will give you exposure to treasuries that are 7-10 years in duration, and TLT will give you exposure to treasuries that are 20+ years in duration.  The main advantage is that there is very minimal default risk on U.S. Government treasuries.  The bad news is that there is very little yield to be had.  That is where the covered call comes into play.

The following example is intended for educational purposes only and NOT a recommendation.

As I’m writing this, you could buy TLT and sell an ATM covered call for January (about 8 months out) for premium of about 4.7%.  Annualized that comes out to about 6.5%.  That is in addition to the income collected from the bond yield itself.  So, you can have U.S. treasury exposure, and have a near 8% yield on your investment by including the interest and the covered calls.  Yes, it is possible. 

Let’s analyze this from all three scenarios.  If the underlying stays the same, you have an 8% annualized yield, that would also be the case if it increases as you would be obligated to sell if called out.  The risk is to the downside.  TLT is fairly volatile.  So, if you make this investment, plan on watching a pretty volatile bond.

If TLT moves too much for you, consider taking a look at IEF.  It is typically not near as volatile.  Now, the disadvantage is that the premium is much less.  However, it is worth taking a look.  The other thing to consider is selling shorter time durations in the covered calls.  That could ultimately lead to a higher overall return, however, it will require more work and you won’t get the same yield right away.

Another spot to look is in the corporate world.  This strategy can also be done with LQD (corporate bond ETF).

Finally, if you are concerned with a major run up on inflation, you can buy a far OTM put for a longer period of time in case we have some crazy bond movement like we did about a year ago.

For more information on this and any other strategy that we do, send me an email at mtosaw@stcharleswealth.com.