Covered calls generate income through call premium received and lowers the risk in the underlying stock position. Obviously, the risk of owning a stock is the price you paid to purchase the stock. Anytime the stock drops below the price paid to purchase the investor is now in a losing position. If you purchase a stock that pays dividends, then dividends collected lowers the purchase price of a stock. For example, you purchase FirstDividend stock (fictional name) for $30 that has a 3.0% dividend yield. The dividend will be $0.90 per year or $0.23 per quarter. After the end of year one, your adjusted share price in FirstDividend will be $29.10 ($30-$0.90). At a yield of 3.0%, your investment will double in 24 years just on the dividend without an increase in share price.
Now, let’s add a covered write to the stock each month. For example, you can sell a $31 call at $0.75 that expires in 30 days. Assuming that we don’t get called out, this will total to $9.00 at the end of year one if we continue to sell a call each month for the $0.75 premium. This will drop the adjusted share price from $30 to $21 or 30% less than the price paid excluding your dividends. This will double your investment in First Dividend in 2.4 years based on the call premium received each month.
If you combine the call premium with the dividend, then the adjusted stock price will be $20.10 at the end of year one. This will further lower your time to double to 2.18 years. This means that at the end of 2.18 years, you will have your total investments returned to you excluding any share price change or dividend increases and still own the stock. This is a great benefit of selling calls against the stocks you hold in your portfolio. In the first year alone, you will have received $990 in income for each 100 shares of stock you own.
The trade-off in writing calls against stock you own is that the topside is capped at the strike price of the call sold. Therefore, you are at risk of selling your stock at the strike price which limits potential upside share price appreciation. This should not be a problem for the investor that is seeking monthly income. You must commit to writing calls for monthly as your chosen strategy to make monthly income and not be concerned that the share price will increase in a month. Of course, if the stock gets called away then you can sell puts to get back into the position. The put premium will serve to lower your adjusted share price just like the call premium in the example above.
You can continue the income cycle by selling puts to buy stock then sell calls when you own the stock. Each month you are lowering your adjusted purchase price until you get your investment back and have a $0 cost in the stock. All the while you are creating monthly income from your investment. The end result is that you get your money for nothing and your stocks for free.
We continue to identify winning option trades to generate income and to exit early as the stock bullish patterns moves prices higher. Try our monthly income plan as you will definitely enjoy the extra cash.
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