The top five holders of this fund are Fort Pitt Capital Group, LLC, 2.12%; Morgan Stanley, 1.85%; Wells Fargo & Company, 1.39%; and Invesco Ltd., 1.35%; and 1607 Capital Partners, LLC, 1.19%. The fund has a current annual dividend yield of 5.22%, paid monthly.
BlackRock Enhanced Capital and Income Fund, Inc. (CII)
From Cabot Dividend Investor
Blackrock Enhanced Capital and Income Fund is a closed-end fund that is designed to provide a high level of current income by employing a covered call writing (or selling) strategy on a diversified portfolio of large-capitalization stocks, as well as provide capital appreciation as a secondary objective.
It is similar to the income strategy used for the sister newsletter of this publication, Cabot Income Advisor. But this covered call ETF enables more passive investors to effortlessly benefit from the strategy. Covered calls are the best way to get a high level of income from securities that would not otherwise generate such a high payout. Let me explain.
A call option is essentially a right to buy a stock at a certain price at a specific date in the future. It is generally a bet that the price of the stock will go up. Buying a call is highly speculative because there is a good chance the stock price will not rise to the specified level by the designated, or expiration, date. If it doesn’t, the option expires worthless, and investors lose 100% of their investment.
Statistics show that about 83% of options expire worthless. Consider the buyer of a call like a gambler in a casino. Every once in a while, he may win big, but the odds are stacked against him.
However, selling, or “writing,” a call when you own the underlying stock position (or a covered call) is a very conservative strategy. When you sell a covered call, you’re like the house instead of the gambler. It’s better to be the house. You’re on the smart side of the deal. Sure, the gambler may win sometimes, but you’ll win a lot more. All those massive hotels in Las Vegas are testament to that fact.
Here’s how it works in more detail.
Let’s say you own 1,000 shares of a $40 stock. You write (or sell) 10 calls (each call represents 100 shares) at a strike price of $44 expiring three months from now for $3 each, or $3,000 total. The stock price must rise above $44 for the option to be in the money; otherwise, it expires worthless. But, either way, you collect the $3 premium.
If you write a call option under the above scenario one of three things will happen at the options expiration date.
- The stock trades flat anywhere below $44
In this case, the options you sold will expire worthless and you keep the stock and the $3,000 income, supplementing your income.
- The stock price falls
In this scenario you also keep the stock and the $3,000 premium. While you do own a stock that has gone down, you still outperform the buy-and-hold investor who just owns the stock by way of the $3,000 premium.
- The stock rises above $44
Your stock will be called, and you effectively sell it at the $44 price even if the stock is a lot higher. You collect your $3,000 premium plus $4 of appreciation on the stock.
The strategy is the best way to generate an extra income, usually in addition to dividends, on the stock. Of course, writing covered calls does sacrifice appreciation potential in exchange for income. In a raging bull market, there will be some opportunity cost. But in most other markets you will likely generate a higher income and total return.
Those are the mechanics of this income-enhancing strategy. But CII does it all for you.
CII has a portfolio of 58 stocks. Top positions include (as of January 29) Microsoft (MSFT, 6.46%), Alphabet (GOOG, 6.22%), Amazon (AMZN, 5.55%), and Apple (AAPL, 4.39%). Sector allocations are Information Technology 27.03%, Consumer Discretionary 15.91%, Communication 15.37%, and Finance 12.38%. Calls are currently sold on a little more than half of the portfolio.
The fund currently yields a very respectable more than 5%, and dividends are paid out monthly. It’s a conservative way to earn a high and regular income without being exposed to the bond market and the risk of rising interest rates.
CII has an excellent track record. It has returned 225% over the last 10 years and 113 over the last five, with average annual returns for the periods of 12.5% and 16.3%, respectively. Even in a bull market, CII has returned on par with the S&P 500 over the last five years and slightly less over the last 10.
Tom Hutchinson, Cabot Dividend Investor, cabotwealth.com, 978-745-5532, July 14, 2021