Updated: Feb 12
Are you looking to generate passive income from your investment portfolio? Covered calls may be the strategy you need to consider. Covered calls are a conservative option strategy where an investor writes (sells) call options on a stock they already own. In this way, the investor generates income from the option premiums while still having the potential to profit from the underlying stock.
What are Covered Calls?
A covered call is a strategy where an investor holds a long position in an underlying stock and simultaneously sells a call option on that same stock. The call option gives the buyer the right to purchase the stock at a specified price (strike price) within a specified time frame. By writing the call option, the investor collects a premium, which acts as a form of income.
The key to a successful covered call strategy is to choose the right stocks and the right options to sell. You want to sell options on stocks that you believe will either remain stagnant or decline in price, while still generating income from the option premiums.
How Covered Calls Work
To understand how covered calls work, let's consider an example. Suppose you own 100 shares of XYZ stock, currently trading at $50 per share. You believe that the stock is unlikely to rise above $55 in the next month, so you sell one XYZ $55 call option for a premium of $2 per share.
By selling the call option, you have essentially agreed to sell your XYZ stock at $55 per share if the option is exercised. But if the stock price stays below $55, the option will expire worthless, and you get to keep the premium.
In this example, you collected $200 ($2 x 100 shares) from the sale of the option, while still having the potential to profit from any stock price appreciation up to $55. This is the essence of the covered call strategy. You are generating income from the option premiums while still having the potential to profit from the underlying stock.
Advantages of Covered Calls
There are several advantages to using covered calls as a part of your investment strategy:
Passive Income: By selling call options, you are generating passive income from option premiums, which can be a significant source of passive income for your portfolio.
Reduced Risk: The covered call strategy reduces the risk of owning a stock by generating income from option premiums. If the stock price declines, you still have the option premiums to offset some of the loss.
Limited Downside: With a covered call, your potential losses are limited to the stock price minus the option premium collected.
Consistent Returns: Covered calls can provide consistent monthly returns of 2% to 4% per month, which can add up to a substantial amount over time.
How to Choose Stocks for Covered Calls Choosing the right stocks for covered calls is a critical component of the strategy. Here are a few tips to help you choose the right stocks:
Look for stocks with low volatility: Stocks with low volatility are less likely to experience large price swings, which makes them ideal for covered calls. However, if your stock is not exciting and not solid, it is probably not ideal either since exciting stocks create more income for options sellers. And solid stocks are ones that you know are going to be around a while like Apple or Google or Amazon.
Consider dividend-paying stocks: Dividend-paying stocks can provide an additional source of income, making them an attractive choice for covered calls.
Choose stocks with high option premiums: Stocks with high option premiums can generate more income from option sales, making them an ideal choice for covered calls.
Look for stocks that are fairly steady and have decent earnings growth, sales growth and Return on Equity as these quality fundamentals should help support the stock when the markets experience selling pressure.
In our Cash Flow Machine Programs, we teach the 4 cornerstones:
The Right Stock
In the Right Market
At the Right Spot on the Chart and
The Right Options (so that we can squeeze the juice (collect income).
How to Choose Options for Covered Calls
Once you have selected the stock you want to use for a covered call, the next step is to choose the right options to sell. Here are a few tips to help you choose the right options:
Sell options with a strike price that strikes a balance between safety and maximizing income. Your highest income will be right At The Money, but you also have more risk of the stock declining with no protection. You should learn strategies to protect your covered calls in case they don’t perform the way you want. Not every stock will go up after you buy it so you should have rules that help you react to those kinds of moves. Be conservative when possible.
Sell options with a short time frame: Options with a short time frame are less likely to be exercised, allowing you to collect the option premium and repeat the process over and over again.
Sell options with high implied volatility: Options with high implied volatility have higher option premiums, allowing you to generate more income from option sales.
Risks of Covered Calls
While covered calls offer several benefits, it is important to understand the risks involved. Here are a few risks to consider: Stock price appreciation: If the stock price rises above the strike price, you will miss out on any potential stock price appreciation. Opportunity cost: By selling the option, you are giving up the potential to profit from any stock price appreciation above the strike price. Stock price decline: If the stock price declines, you will still be holding the stock and will experience a loss. You need to have a strategy if this happens.
Conclusion Covered calls can be a powerful tool for generating passive income and reducing the risk of your investment portfolio. By choosing the right stocks and options, you can generate consistent monthly returns of 2% to 4% per month. However, it is important to understand the risks involved and to carefully consider your investment goals and risk tolerance before implementing this strategy.
Would you like to learn how to create income of 2% to 4% per month? Our programs are designed to build multi-million dollar portfolios that create reliable income of $10K, $20K, or $30K per month. Click here to get our weekly stock tips. Or check out my FREE Masterclass
About Mark Yegge
Mark Yegge The Wealth Architect "Never give up your power in your health, your wealth or your time."
Mark Yegge is a recognized Wealth Architect, Hedge Fund manager, Author and Teacher in the Financial sector and the personal development arena. He has helped thousands of 6- and 7-figure investors create strategies for increasing returns, decreasing risk and reducing tax impact from investing. He is a co-founder of several mastermind groups helping successful people augment their lives in the areas of wealth, health, relationships, spirit and lifestyle. Some of his recognized programs include:
The Cash Flow Machine (www.CashFlowMachine.io)
The EPIC Mastermind (www.JustBeEpic.com)
Stock Trade Genius University (www.DestinyCreation.com)
Trade Like A Pro (www.DestinyCreation.com)
Hacking Money (book, course, and website) (HackingMoney.com) (on Amazon)
Negotiate To Win-Win (book, audio book, course, website) (on Amazon)
The Secrets of Business (book, website) (on Amazon)
The Regular Paycheck Strategy (www.CashFlowMachine.io)
...and much more.....
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