Writing covered calls

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.


7 thoughts on “Writing covered calls

  1. can you also let us know in which cases using Options could loss money as retirees? as much as I like to get passive income like this (either way one will get premium at least), you sure options won’t loss money? as you know, retirees can’t afford to lose.

    1. Hi Linda,
      Selling covered calls can’t lose you money on the options themselves as long as you hold them thru option expiration. Today my MDY July 20th 360 calls are los By money on paper because the underlying stock is higher. However, if I hold the options thr expiration on 7/20 I cant lose. I’ve collected the upfront premium and it’s mine to keep. The worst thing that can happen is the stock is called away at $360. That means I’ve made profit on the stock, though I capped the upside potential.
      As a retiree, you’re correct; you can’t risk losing money. If you already own Individual stocks of ETF’s, sellers by covered calls against those positions will increase income for you. If it were me I’d want to make sure the strike price is far enough our of the money that if the stock is called away, I make a decent profit. If the options strike is too far out of the money, the premium is less and it may not be worth it. Higher prices stocks offer generous premium. AAPL or IBM for instance; they trade at high prices and the option premium is much higher. You wouldn’t want to sell covered calls on a low-prices stock like GE. You probably wouldn’t on AT&T either.
      I hope this answers your question.
      (Selling puts is a different story. You can lose money with that strategy and it takes more monitoring and “Baby-siting” than simply selling covered calls).

  2. thanks for the cool tips…
    so you’re writing puts for stocks you want to own but at lower price (just be sure to have enough cash for stocks put to you), writing covered calls for stocks you want to get rid of or trim anyway, right?
    I sure need to learn more about options to make it as a very conservative play as one is very risk aversion near retirement.
    looking forward you talking more about options.

    1. Good morning Linda. You have my style down perfectly! I recommend you purchase the book,”the option machine.” The link is on my blog under “menu” it’s a fantastic book (ebook) available at Amazon and this is how I learned how to do it. It’s spelled out by the author and it all makes perfect sense. Out of the literally dozens of trades I’ve only experienced a handful of small losses from selling outs and never a loss from selling calls.

  3. I sure will get that book!
    Once in distribution stage (retirement) selling calls without loss is great!
    Here’s the rub: I am still several years from retirement so I am still accumulating–hoping to get shares at better price (selling puts). I am wondering if you can write next about what’d you learn to avoid those loss from selling puts—if you think it’s unrealistic to have 0 loss then forget about it. Because I am trying to do it in my Roth and those loss, however small can not be claimed against other income when filing tax return so I am very nervous about that.

  4. I’m not a fan of writing covers calls. I think it puts you in a position opposite of what you should be. Everything I know says you should cut your losses and let your winners run. Writing covered calls effectively puts a cap on your gains and in a move against you, they don’t make up for your stock losses due to a lower delta.

    1. I can see your point but it’s an option strategy that is very popular and I use it myself quite often, not so much as a hedge but for income. If the stock is called away I’m okay with that as I lean bearish most of the time anyway. I don’t own stocks for long. A long term capital gain for me is about 45 days!

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