Agreed. And unless you get a stock that pays monthly dividends, the whole plan can go to shit if something happens within that year. Anything can happen over the course of the year, even with historically safe stocks.
If you're looking for an income generating strategy, covered calls are definitely the way to go.
It's funny because traders (ie, active traders who aren't necessarily 'investors') or wannabe traders generally don't like the strategy because earning 1.5-2% is not sexy enough. They's would rather flip contracts in the hope of making large gains, but the majority just end up losing.
Normal people that want to invest some money, but aren't necessarily experts when it comes to investing, freak out when they hear 'options', so they don't even consider the strategy.
It's really simple, though. Think of it this way. A stock can do 5 things. They are as follows:
1. Go way up
2. Go up just a little bit
3. Remain the same
4. Go down just a little bit
5. Tank
Using 1000 Bank Of America shares priced at $10.54 as an example.
This is what today's option chain looks like for calls with a July 16 expiration.
http://www.google.com/finance/option_chain?q=NYSE:BAC
Strike Price Change Bid Ask Volume Open Int
11.00 0.28 -0.03 0.27 0.28 16394 36520
12.00 0.08 -0.01 0.07 0.08 14671 144348
Traders/investors purchased 16,394 contracts which will allow them to purchase 100 shares of Bank of America for $11.00 per share provided that it closes at or above $11,00 on July 16th. They paid approximately $0.28 ($28) for each contract, which means that their break even point is $11.28.
By and large, they are either banks/funds that have a complex hedge strategy, day traders, and amateurs who read a few articles and think they know what they're doing, but are pretty much just idiots. Many from that last group are just hoping that if BA has a strong week next week, they can maybe sell the contracts for a quick double digit percentage gain before the time decay accelerates.
When you're selling covered calls, you're essentially just helping them feed the monkey.
You own 1000 shares at an outlay of $10,540. You sell 10 contracts for $28 each and pocket $280. After transaction fees, let's say that you actually pocket $210, which is about 2% of your outlay.
Now, here is what happens for each of the 5 scenarios.
1. Stock goes way up
If the stock closes at $11.00 or above on 7/16, your shares will be 'called out' and automatically sold for $11.00 per share. Factoring in the $210 that you made when you sold the calls, you actually get a total of $11.21 per share on the sale. If it closes above $11.21, the lost 'opportunity' might upset you for a little bit, but then you'll realize that it was likely an anomalous situation and you still made over $0.67 per share before taxes, or 6%, you'll be fine, and you can just buy more shares on Monday and repeat the process.
2. Stock goes up a little bit
The 'sweet spot' is if it closes at $10.99, because you keep your $210 from the calls, earn an extra $0.45/share in appreciation, and keep the shares. That's $0.66 per share without the short term cap gains, and without having to deal with repurchasing the shares on Monday. Likewise, if it closes at $10.70, that's a net profit of $0.37 per share.
3. Stock remains at $10.54
You keep your $210. Keep in mind that this is something you'll be doing every month. $210 per month for a year equates to a 24% annual return if the stock remains the same!
4. Stock goes down a little bit
Since you keep the $210 no matter what, your break even point for the 7/16 expiry is $10.33 ($10.54-$0.21).
5.Stock Tanks
This is the only situation where it can get tricky. If the stock starts plummeting and you need to sell ASAP, the only way you can do so is if you buy back the calls. If there's an overwhelming negative catalyst and the stock drops 15-20%, you would buy back the calls at a fraction of what you sold them for, so let's say $0.02 per contract ($20) and then sell the shares at $9 each. All that means, though, is that at the end of the month, you'd end up with $8980 instead of $9000. If you want, you can also factor in that it will likely take you a little bit longer to sell the plummeting stock, because you have to buy back the calls first. Maybe you could of sold for $9.20 instead of $9.00.
In sum, you will be fine in 4 of the 5 possible stock movement scenarios and, if it tanks, you will be only slightly more fucked than you would have been had you not sold the calls.