Passive income is the best kind of income because you get paid no matter what you're doing at the time -- travelling, working your regular job, enjoying your friends, etc; it doesn't matter, you still receive the income. Earning interest is an example of passive income. So is collecting dividends. What's not to like? The good news for investors who owns stocks or ETFs is that there is another type of investment that is passive in nature and easy to implement -- called covered calls.
Before we can talk about covered calls, let's talk about calls. A "call option" is an investment that gives the buyer the right to purchase stock at a certain price before a certain date. In exchange for this right the buyer pays 'premium' (money) to the option seller. If the buyer then decides he wants to exercise his right, the seller is required to sell the shares at the agreed upon price (but the seller keeps the premium).
As an example, let's say Bob wants to buy 100 shares of XYZ for $50 between today (December) and three months from now. Bob buys 1 call option on XYZ stock with a strike price of 50 and an expiration date of March (for example). Let's say XYZ is trading for $45 today and so Bob might pay $100 for the right to buy XYZ at $50 between now and March. He would do this because he thinks XYZ will rise above $50 between now and March. If XYZ shoots up to $60 then Bob can exercise his right and force the seller of the option to give him 100 shares of XYZ at the strike price ($50/share). Bob has to pay $5000 for these 100 shares. He can then turn around and sell the shares in the open market for $6000, pocketing $1000 (less the $100 in premium he paid to the seller when he bought the call option). However, if XYZ finishes below $50 in March then Bob's option expires worthless and he loses the $100 in premium he paid.
Generating recurring income by selling covered calls to other people is not difficult. If you do it with stocks you already own then the call options you are writing are 'covered' (because if the options you sold are exercised against you, you already own the shares you will need for delivery). If it happens that your stock is called away then you receive the strike price per share for your shares. If you still want to own the stock then you can either buy back the option before it expires, or wait until it is exercised and then use the proceeds to go buy more shares to replace the ones you lost during assignment.
Using covered calls to create monthly income is common (in fact, it is the most popular option-based strategy). It is a passive income strategy that lets you collect option premium each month as time passes. If an option buyer exercises the option the only thing that happens is that he will pay you for your stock. You still make money. Another nice feature is that the option premium you collect each month gives you current income and some downside protection. Covered calls are easy to learn and execute and should be done by anyone who owns stocks or ETFs. If you're not writing covered calls then you're leaving money on the table each month.
Before we can talk about covered calls, let's talk about calls. A "call option" is an investment that gives the buyer the right to purchase stock at a certain price before a certain date. In exchange for this right the buyer pays 'premium' (money) to the option seller. If the buyer then decides he wants to exercise his right, the seller is required to sell the shares at the agreed upon price (but the seller keeps the premium).
As an example, let's say Bob wants to buy 100 shares of XYZ for $50 between today (December) and three months from now. Bob buys 1 call option on XYZ stock with a strike price of 50 and an expiration date of March (for example). Let's say XYZ is trading for $45 today and so Bob might pay $100 for the right to buy XYZ at $50 between now and March. He would do this because he thinks XYZ will rise above $50 between now and March. If XYZ shoots up to $60 then Bob can exercise his right and force the seller of the option to give him 100 shares of XYZ at the strike price ($50/share). Bob has to pay $5000 for these 100 shares. He can then turn around and sell the shares in the open market for $6000, pocketing $1000 (less the $100 in premium he paid to the seller when he bought the call option). However, if XYZ finishes below $50 in March then Bob's option expires worthless and he loses the $100 in premium he paid.
Generating recurring income by selling covered calls to other people is not difficult. If you do it with stocks you already own then the call options you are writing are 'covered' (because if the options you sold are exercised against you, you already own the shares you will need for delivery). If it happens that your stock is called away then you receive the strike price per share for your shares. If you still want to own the stock then you can either buy back the option before it expires, or wait until it is exercised and then use the proceeds to go buy more shares to replace the ones you lost during assignment.
Using covered calls to create monthly income is common (in fact, it is the most popular option-based strategy). It is a passive income strategy that lets you collect option premium each month as time passes. If an option buyer exercises the option the only thing that happens is that he will pay you for your stock. You still make money. Another nice feature is that the option premium you collect each month gives you current income and some downside protection. Covered calls are easy to learn and execute and should be done by anyone who owns stocks or ETFs. If you're not writing covered calls then you're leaving money on the table each month.
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This article on covered call options is brought to you by Born To Sell. Click here to go to Born To Sell's website on covered call investing.
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