Covered Calls on SCHD: Maximizing Income and Managing Risk

Covered calls are a popular strategy among investors looking to generate income from their stock holdings while potentially reducing some of their downside risk. In this article, we’ll dive deep into how covered calls work, their benefits, and how you can use this strategy with the SCHD ETF, which is known for its strong dividend performance.

What Are Covered Calls?

A covered call strategy involves holding a long position in a stock or ETF and selling call options on that same asset. By selling the call option, you give the buyer the right, but not the obligation, to purchase the stock at a specified price (the strike price) before the option expires. In return, you receive a premium, which can provide additional income on top of any dividends you might already be earning.

The SCHD ETF

SCHD, or the Schwab U.S. Dividend Equity ETF, is an exchange-traded fund that focuses on high dividend yielding U.S. stocks. This ETF is popular among income-focused investors due to its strong track record of paying dividends. SCHD aims to track the performance of the Dow Jones U.S. Dividend 100 Index, which includes high dividend yielding U.S. stocks with a record of consistent dividend payments.

Why Use Covered Calls on SCHD?

1. Enhanced Income: By writing covered calls on SCHD, investors can generate additional income through the premiums received from selling call options. This can be particularly appealing in a low-interest-rate environment where traditional income sources may not be as rewarding.

2. Reduced Downside Risk: The premium received from selling the call option can act as a cushion against potential declines in SCHD’s price. While this doesn’t eliminate risk, it does provide a buffer that can mitigate losses.

3. Stable Holdings: SCHD’s focus on high-quality dividend-paying stocks means it is generally less volatile compared to other stocks. This stability can make it a good candidate for the covered call strategy, as the stock price is less likely to swing wildly, reducing the risk of the options being exercised.

How to Implement a Covered Call Strategy with SCHD

1. Hold SCHD Shares: To write covered calls, you need to own shares of SCHD. Ensure you have a sufficient number of shares to cover the options you plan to sell. Each option contract represents 100 shares.

2. Choose an Expiration Date: Select an expiration date for the call options you want to sell. Shorter expiration dates generally result in higher premiums, but they also require more frequent management. Longer expiration dates provide more time for the underlying asset to move, potentially leading to more favorable outcomes.

3. Set the Strike Price: Determine the strike price at which you’re willing to sell your SCHD shares. This price should reflect your outlook on SCHD’s future price movements. If you believe SCHD will remain stable or rise slightly, you might choose a strike price that’s slightly above the current trading price.

4. Sell the Call Options: Execute the sale of the call options through your brokerage account. You will receive a premium for each option contract sold, which will be credited to your account.

5. Monitor the Position: Keep an eye on SCHD’s price and the performance of your call options. If SCHD’s price approaches the strike price, there’s a higher chance the options may be exercised, and you could be required to sell your shares at the strike price.

6. Adjust as Needed: Based on market conditions and your investment goals, you may need to adjust your covered call strategy. This might involve rolling the options (buying back the current options and selling new ones) or managing the underlying SCHD shares.

Potential Risks and Drawbacks

1. Limited Upside Potential: One of the main drawbacks of a covered call strategy is that it caps the potential gains. If SCHD’s price rises significantly above the strike price, you will miss out on any further appreciation above that level, as your shares will be called away.

2. Losses on Decline: While the premium from the call options provides some buffer against losses, it may not fully protect against significant declines in SCHD’s price. Investors should still be prepared for potential losses.

3. Option Management: Covered call writing requires active management and monitoring. Investors must be vigilant about the expiration dates and strike prices of their options and be ready to adjust their positions as needed.

Using Data to Inform Your Strategy

To make informed decisions, consider analyzing historical performance data and market conditions. For instance, look at the historical volatility of SCHD and the premiums received from covered calls over various time periods. This can help you gauge the effectiveness of the strategy and make adjustments as needed.

Table: Historical Covered Call Premiums on SCHD

Expiration Date	Strike Price	Premium Received	SCHD Price at Expiration	Profit/Loss
30 days	$75	$1.50	$76	$1.50
60 days	$77	$2.00	$80	$2.00
90 days	$80	$2.50	$85	$2.50

This table illustrates the premiums received for various expiration dates and strike prices, compared to SCHD’s price at expiration. Adjusting your strategy based on such data can enhance your results.

Conclusion

Covered calls on SCHD can be a valuable strategy for investors seeking to enhance income and manage risk. By holding SCHD shares and selling call options, you can generate additional income while potentially reducing some downside risk. However, it’s crucial to understand the limitations and actively manage your positions. With careful planning and monitoring, covered calls can be an effective tool in your investment strategy.