In a previous article I provided a discussion on writing put options as an alternative to owning common stocks. It’s a passive cash flow method I use on a consistent basis. Besides dividend payments, how does an investor generate income from the common stocks they already own? The simple answer is by writing covered calls.
Writing covered calls is considered the most conservative of all options trading strategies. You are selling someone the right to own your stock at a predetermined strike price. (Use the link in previous sentence for a detailed explanation of covered call writing)
Here is an example of a covered call trade I personally placed today:
I currently own 300 shares of the madcap ETF, $MDY with a cost basis of $357.80/share. Today I sold the $MDY July 20th 360 calls and collected a premium of $2.90 per contract (actually $290 per contract x 3 contracts or $870.). This means that if on July 20th option expiration if $MDY closes below $3.60/share I keep all of the premium I collected. On the other hand, if $MDY closes above $360 I’ll keep the premium I collected ($870.) and my stock will “be called away” at $360.00/share, recording a capital gain of $2.20 per share or $660. (+ the $870. I collected = total gain of $1530.).
The upside is that I collected extra income of $870. The downside is that I capped the gain on the stock of only $2.20 per share. Another upside is that if the stock isn’t called away, I”ve effcetively lowered my cost basis on the ETF by $2.90 due to the premium collected. If $MDY is not called away I plan to sell 3 more call options for the following option expiration in August.
Covered call writing allows investors a way to earn consistent passive income from the stocks and ETF’s they own. This is a goose laying a golden egg for retirees! It’s also a way to slightly hedge your stock and ETF holdings. This hedge isn’t effective in a 10% market correction but it is a useful hedge when the markets are stuck in a trading range like the one we’re in now. I use covered call writing on a regular basis and I consider it a wonderful cash flow method. It can even be done in an IRA, as long as you sign an options agreement with your broker.
DISCLAIMER: This is not advice! Stock and option trading is risky. This blog does not act as an investment advisor, all articles are for informational purposes only and the reader/investor assumes all risks.