A key driver of income from investing, selling options on stock that you already own should be a part of every investor's system.
This is a hot topic, and for good reason. It is the most popular method of generating income and potentially outsized returns. That's right, use this strategy to boost your returns, generate income, and reduce your cost basis.
This strategy goes by the popular name: Covered Call. This is where you sell Out of The Money Call options on stock that you already own. Quick mechanics of this trade: You can sell one call option for every 100 shares. Typical returns on volatile stocks can be over 2% per month.
TLDR: Earn 20% per year by selling call options every month!
Let's review a few scenarios that could play out. The following scenarios are really great examples of where this strategy truly shines.
Scenario 1: Your stock is trading sideways stuck in a channel and you don't see much growth on the horizon.
In this case, your options are generally to hold the stock and pray that it goes up eventually. Or sell the stock, take whatever tax hits you're going to take and move on. But, selling covered calls on the shares offers a third choice. Keep the stock, don't worry if it goes up or not and make some extra income!
Scenario 2: Your stock is a growth stock and it only goes up.
In this case, when you sell call options on your stock, you cap the upside. If the stock goes up faster than your calls expire worthless, then your shares will be called away. This is usually fine, but if the stock goes up a lot, you could end up being upset that you missed out on the upside as your shares get called away at the strike price of the option.
If you're in a growth stock and still want to try this out, it is best to sell call options that are way way out of the money. This way you'll capitalize on as much of the upside as possible while still bringing in some income.
Scenario 3: Your stock reported some bad earnings and it might be in for an extended down turn or at best trade flat.
In this scenario, instead of chasing the stock price up, you're sort of chasing it down. You'd be interested in selling call options with a delta closer to 50, closer to At The Money. They will pay a lot more, and you expect the stock to go down, so you need the extra income to offset more of the losses from that.
The downside? If the stock falls too fast, you can't keep up. Meaning you can't sell enough call option premium to offset all of the losses. And if the stock price falls enough, you won't be able to sell any call options below your cost basis. Why is that important... If you sell call options below your cost basis, and the stock pulls a fast reversal on you (happens all the time) then you lock in losses by having your shares called away at a lower price.
In Summary
No matter what the market is doing, or what your stock is doing. selling options on stock you own can be very beneficial to your portfolio. There are quite a few calculations that go into choosing the options. If you want help with that, please see Tiblio's Covered Call Screener.
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