How To Increase The Yield On Bond Investments

With markets looking increasingly volatile, investors might be more interested in generating income rather than capital gains. 

Bond investments have seen significant capital losses this year as inflation rages and the Fed begins to raise interest rates. But those fears appear to be easing now and ETF’s like have bounce significantly off their lows.

As sophisticated investors, we can generate increase the yield provided by bond ETFs through the use of options. The strategy is a known as a covered call which involves selling call options against a stock position.

Let’s use TLT as an example.

TLT Covered Call Example

When running the Covered Call Screener for TLT, we find the following results:

Let’s evaluate the first TLT covered call example. Buying 100 shares of TLT would cost $11,644. The January 2023, 120 strike call option was trading yesterday for around $5.70, generating $570 in premium per contract for covered call sellers. Selling the call option generates an income of 5.15% in 190 days, equalling around 9.89% annualized. That assumes the stock stays exactly where it is. What if the stock rises above the strike price of 120?

If TLT closes above 120 on the expiration date, the shares will be called away at 120, leaving the trader with a total profit of $926 (gain on the shares plus the $570 option premium received). That equates to an 8.36% return, which is 16.0% on an annualized basis.

Let’s look at another example using a shorter-term expiration.

Instead of the January 120 call, let’s look at the October 120 call. Selling the October 120 call option for $370 generates an income of 3.28%, but in only 99 days, equalling around 12.10% annualized.  If TLT closes above 120 on the expiration date, the shares will be called away at 120, leaving the trader with a total profit of $726 (gain on the shares plus the $60 option premium received).

That equates to a 6.4% return, which is 23.5% on an annualized basis.

Of course, the risk with the trade is that the TLT might drop, which could wipe out any gains made from selling the call. Traders that think bond yields will continue to rise (and prices drop) would not enter this trade.

Barchart Technical Opinion

The Barchart Technical Opinion rating is a 64% Sell with a weakest short term outlook on maintaining the current direction. Long term indicators fully support a continuation of the trend.

Implied volatility is at 22.23% compared to a 12-month low of 11.75% and a 12-month high of 26.17%. The implied volatility rank is 72.70% and the IV percentile is 88%.

TLT currently yields around 2.01% annually.

Profile

The iShares 20 plus Year Treasury Bond ETF seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years.

Bond investments are a common component of most investment portfolio, but they have suffered significant capital losses recently. Using covered calls can increase the yield component of your bond investments. 

Please remember that options are risky, and investors can lose 100% of their investment.  This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

*Disclaimer: On the date of publication, Steven Baster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. Data as of after-hours, July 13, 2022.

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