I've been one of them. Ignoring options just because they were too hard to understand. Little did I know how big of an opportunity I would miss.
Once you learn options, a whole new world opens up for making more money in the markets. One such way is selling options for a monthly passive income.
If you're new to options and don't know what options contracts are, don't worry. I have created a complete options guide for you to better understand them:
Johannes Dragulanescu
The most popular passive income strategy
As we all know, the most popular passive income strategy is dividend growth investing. Once you build up your portfolio, you can live off dividends without having to buy or sell any stocks.
With dividend investing, you can buy shares of good solid companies that grow their dividends over time and keep them for life while watching them compounding. The secret is to start this process as soon as possible for this snowball effect to come faster.
Here's an article I wrote about dividend growth investing if you'd like to read more about how to choose the right companies: Why You Should Consider Dividend Growth Investing?
Options selling recap
Whenever we hear about options we think of risky plays where you can win or lose a lot of money. This is true when you buy call or put options, as you're essentially betting that the stock price will move in your desired direction. But what if you change your approach and sell those contracts to other people willing to place those bets? In this case, you essentially become the one getting paid by those who are willing to risk and take these chances.
Think of it this way, when somebody buys a call option, they have the "right" not the "obligation" to buy the shares of a specific stock at a specific price within a specified timeframe. You as a seller of a covered call, agree to sell those shares at that specific price should the buyer exercises his right.
Provided that you purchased those shares at a lower price than the option strike price, then you have nothing to lose. You will always get a profit from this option but you will miss out on the opportunity to have made more money should the stock price increase in value above the agreed strike price. Selling covered calls you become the casino where the house always wins, you are the one controlling the odds.
There's also the other option, when somebody buys a put option, they have the "right" not the "obligation" to sell the shares of a specific stock at a specific price within a specified timeframe. You as a seller of a cash-secured put, agree to purchase those shares at that specific price should the buyer exercises his right.
In this case, you must be willing to own a specific stock. You can control at what price you like to buy the shares and collect a premium from those willing to protect their portfolio against a sudden crash. Selling cash-secured puts you become the insurance company, willing to cover the risks for a premium fee.
The nice thing about selling puts is that you know your return of investment immediately as opposed to buying shares. For example, when you sell a cash-secured put, you must tie up the collateral for buying 100 shares at the agreed strike price and you receive a premium in return. Let's say you sell a put for 6 months and get an 8% guaranteed return, you then know that you either get assigned and buy the shares at the price you wanted, or you receive an 8% return for your investment that leads to 16% annual return.
You could argue that yes, you tie up that collateral for 6 months time, however when you buy the shares outright then you tie up that cash anyway. To be honest, I can live with this kind of guaranteed return of investment any time of day.
The best time to sell options is when the market is volatile as when the stocks have high implied volatility, the premium will be higher. The reason for this is because the option's extrinsic value is obtained from adding the time value with the volatility.
Cash flow boost selling covered calls
Selling covered calls is a great way to boost your cash flows while holding a specific stock. One powerful strategy to boost the returns is to sell out of the money covered calls while owning shares for dividend-paying companies.
This way you receive an extra premium on top of your dividend payments without too much risk of losing the shares. In case the price goes up closer to be in the money, then you can either roll your option further out or close it to reduce the risk of losing your shares.
While companies often pay their dividends quarterly, you can fill in the gaps by selling calls on a monthly basis. You can also reinvest the premium collected and buy more shares to start the compounding snowball quicker.
Always make sure you don't sell covered calls in the week before the stock's ex-dividend date as it's possible to get assigned and lose the shares, losing the dividend payment in the process.
Selling covered calls is a great way to take a break from buying shares when there is a high bearish sentiment in the market or if the stocks are overvalued.
Covered call ETFs
As an alternative to selling options for income yourself, you can always invest in ETFs that do exactly this. These ETFs are designed to enhance the dividend payouts by selling covered calls, exactly as described in the strategy above.
A major benefit of investing in a covered call ETF is that it reduces the risk of making mistakes and it simplifies the process for investors that don't have the knowledge for trading options. Another benefit is diversification as it may be really hard to diversify your options portfolio due to the high capital requirements as you need to have 100 shares of each particular stock you want to trade options for.
Here are a few good covered call ETFs, all paying dividends of approximately 7% or higher:
- QYLD - The Global X Nasdaq 100 Covered Call ETF (QYLD) follows a covered call strategy, in which the fund buys the stocks in the Nasdaq 100 Index and sells corresponding call options on the same index, saving investors the time and potential expense of doing so individually.
QYLD seeks to generate income through covered call writing, which historically produces higher yields in periods of volatility. The dividends of this stock are paid on a monthly basis. - XYLD - The Global X S&P 500 Covered Call ETF (XYLD) also follows a covered call strategy, but with stocks from the S&P 500 Index.
- NUSI - Nationwide Risk-Managed Income ETF targets high monthly income and offers downside protection by hedging the market.
- JEPI - JPMorgan Equity Premium Income ETF is another very popular covered call ETF. It generates income through a combination of selling options and investing in U.S. large cap stocks, seeking to deliver a monthly income stream from associated option premiums and stock dividends. It also constructs a diversified, low volatility equity portfolio that seeks to deliver a significant portion of the returns associated with the S&P 500 Index.
The main downside for investors outside the US is that it is really hard to get access to those ETFs due to different regulations. After I searched where I can trade them, you either have to have special professional accounts or have high capital to get access to those US ETFs.
The only platform where I was able to find and trade a covered call ETF without special privileges in the UK was eToro at the moment. One note to make is I could only find QYLD in eToro's ETF list.
Access to these funds is possible via CFDs (contracts for difference), and eToro pays you the dividends. Be aware that CFDs are often leveraged positions and may result in losses higher than expected.
eToro (Global): https://etoro.tw/3zfEoUM - You can support me by using my eToro referral link if you decide to open an eToro account. 67% of retail investor accounts lose money when trading CFDs with this provider. Your capital is at risk. Other fees may apply.
The infinite options selling strategy: The Wheel Strategy
The Wheel Strategy is my main options trading strategy for constant passive income. I have briefly mentioned it in my complete options guide, and I will showcase it here as well.
The main goal is to keep selling options on stocks that you don't mind owning to generate a monthly income.
The process is very simple. You sell cash secured puts on a stock until you get assigned and receive the shares, then you sell covered calls on the assigned shares until the option is exercised and you have to sell your shares. Repeat the process.
I usually like to keep a short expiration date of around 1-2 weeks and have a delta of 0.30 or under meaning, I will have around a 30% chance to be assigned. Sometimes I would choose a strike price closer to the stock price if I really want the shares at that price.
The main risk of this strategy is the stock itself as when the price drops you will need to buy the underlying shares at a price higher than it currently is, resulting in a loss. If the price keeps going lower you may not be able to sell a covered call with a strike price higher than your cost basis, forcing you to wait for the share price to increase until you can continue with this strategy.
This is the reason why you should be happy with the current price of the stock when you start selling the put option and also why you should consider a high-quality stock. You should never choose stocks that you don't want to own for the long-term as you may not be able to sell the shares for a while.
I have learned this the hard way when I sold a put option for a bad stock right before they announced earnings. When they turned to be worse than expected, the stock dropped 15% forcing me to buy shares I didn't want to own at a higher price, forcing me to wait and lock my capital. You should be very careful when trading options right before earnings as they can be very unpredictable.
The bottom line
Selling options is a whole different game compared to buying options. You are the one in control, making the odds gaining the premium from those willing to take the chances or those willing to pay a fee to have insurance for their gains.
It's an amazing tool to enhance your dividend returns giving you a steady monthly income that will speed up your portfolio compounding effect.
