You can build wealth while creating monthly income by trading covered calls on dividend stocks with a protective put to control downside movement. This has been my strategy for over a decade with winning years each year.
To use covered calls as part of a wealth-building strategy:
- Start Small: Begin with a low-cost ETF or a stock you’re comfortable holding long-term. Practice with one contract to learn the mechanics.
- Build a Diversified Portfolio: Combine covered calls with other income sources (e.g., dividends, bonds, or real estate) to reduce reliance on one strategy.
Reinvest Premiums: Use premiums to buy additional shares or diversify, compounding returns over time. - Educate Yourself: Study options basics and risk management. Resources like the Options Playbook or brokerage tools (e.g., Fidelity’s Option Strategy Builder) can help.
Avoid Common Mistakes:
- Don’t sell calls on stocks you’re extremely bullish on, as you’ll miss significant gains.
- Avoid highly volatile stocks or leveraged ETFs, which increase risk.
Practical Example
- Suppose you own 100 shares of Apple (AAPL) at $195. You sell a 30-day $200 call for a $5.60 premium ($560 total). Possible outcomes:
- Stock Stays Below $200: The option expires worthless, you keep the $560, and retain your shares. Annualized return: ~2.8% per month if repeated.
- Stock Rises to $205: Your shares are called away at $200. You gain $5 per share ($500) plus the $560 premium, totaling $1,060 profit. However, you miss out on gains above $200.
- Stock Drops to $190: You keep the $560 premium, but your shares lose $500 in value, netting a $60 gain. Significant drops could lead to larger losses.
- Buy Protective Put with a strike price 5-10% below stock purchase price. This will protect your capital in an unforeseen stock price move lower. You sell the Put when you exit the position.
Key Takeaways
- Covered call trading can generate consistent income, typically 3-12% annually, but it’s not a shortcut to riches. Success requires:
- Selecting stable stocks or ETFs with high implied volatility.
- Selling OTM or ITM calls based on your risk tolerance and market outlook.
- Actively managing positions through rolling or hedging.
- Diversifying income sources to mitigate risks.
- Maintaining realistic expectations and avoiding overhyped claims (e.g., 50-100% returns).
