Succeeding in writing covered calls for a living is determined by various factors, including the performance of the underlying stock, the premiums received from selling options, and the investor’s ability to manage positions effectively. Here are 10 key considerations when assessing the average return from selling covered calls.
10 Thoughts About Writing Covered Calls For A Living
1. Premium Income
When it comes to stock options, the premium means simply the amount gained per share through selling the contract as the writer. This number is multiplied by 100, since a contract needs 100 shares to be written as a covered call in fact.
So if the premium is $0.70 per share, $70 would be gained at expiration, whether the shares are sold off and increase in value past the strike price, or whether they remain with the seller and are somewhere below the strike price officially at the expiration date.
The primary source of return in covered call writing is the premium income received from selling call options. The premium is the price paid by the option buyer for the right to buy the stock at the predetermined strike price.
As can be understood, the buyer would do this in order to later buy at a lower price, as that buyer expects the stock value to go quite higher (according to strike price) during the specific time period (expiration date provided). If the stock goes very high, paying the lower premium price of the lower strike price could result in quite a gain for the contract buyer.
2. Strike Price Selection
Basic math. Know how to figure out if the strike is worth it overall. If it’s lower than the current value, say by $0.20 for each stock, then selling the contract better end up being more than $20 in total premium, just to break even. If the premium brings back $40 for a contract, but the strike is actually just $0.20 below the current stock value, then that results in only $20 gained at the end of expiration. So know the math involved.
Second, most of the time, it’s likely most investors sell strikes above the current value, so money is gained from stock increase plus gained from the premium. Though in a bearish market or stock downtrend, it may be advantageous to sell a strike price contract that’s just below the current value and has a decent premium. One must know the math in order to make the right positive financial play here.
The choice of the strike price plays a crucial role in determining the potential return. Opting for a strike price that is lower than the current market price (or around the same) may yield a higher premium but also increases the likelihood of the stock being called away.
Best Time To Sell Covered Calls
3. Stock Performance
Quickly visit market news before actually selling a contract.
Simply assess the overall market before selling the contract. Is it bullish? Does the stock stand to gain substantially over the selected time period? Is it bearish? Is there some significant chance of stock value decrease? Might a contract near the current value price or somewhat lower price make more financial sense, due to bearish conditions?
The overall performance of the underlying stock influences the return. If the stock remains below the strike price, the options may expire worthless, allowing the investor to keep the premium as income and retain ownership of the stock.
Through playing smart with these considerations, even a 1% gain over a month is preferable to money sitting stale in a bank account.
4. Opportunity Cost
The opportunity cost is a consideration when the stock’s price rises significantly above the strike price somewhere during the contract period. In such cases, the investor may miss out on potential capital gains beyond the strike price.
However, gaining income steadily over time can easily beat missing out, even on some missed opportunities. Having money come in that is counted on can mean less risk and missed chances, but may be worth it for a stable and peaceful mind. The downside protection covered calls offer is great indeed.
Hence, it is better to receive a stable income than nothing at all through being too risky. Stability can be learned and applied in the world of selling options.
5. Management and Adjustments
Successful covered call writing often involves active management.
If you want to actually keep the stock for a more lengthy period, and have captured some premium already during the open contract phase, consider closing it and just taking some profit. Alternatively, roll the contract up and out. Close the current one and roll it up by another strike price or two, and roll it out by making the expiration date another month or so into the future.
Rolling it up prevents the ease of having the shares called away, while rolling it out allows more time consideration with more premium.
If the current contract of consideration happens to show a slight loss, going up and out brings that value back. Simply subtract the slight loss from the further-out contract’s premium, though you would need to wait longer to collect.
If not wanting to actually keep the stock over time, that’s okay too. Investors may choose to roll options (buying back the current option and selling another with a later expiration) or close out positions, simply just to capture profits or minimize losses.
6. Market Conditions
Market volatility can impact the premiums offered for options. Higher volatility may lead to higher premiums, potentially increasing the average return. However, it also comes with increased risks.
Again, through visiting a market-based site, one can gather info about the current state of the S&P 500 or the QQQ tech-based side of things for example. Just get a simplistic concept of where the market stands before opening the covered call contract.
Doing this simple step that takes seconds can help save money or even gather up some extra.
Covered Call Writing For Income
7. Frequency of Trading
The frequency with which an investor sells covered calls can affect the average return. Some investors engage in this strategy regularly, aiming to generate income consistently, while others may use it selectively based on market conditions.
The alternative on-off strategy with option selling involves using the contracts every so often and putting money to even better use when the market timing allows. Maybe $1,000 into a very cheap stock will yield far greater returns over the coming 3-6 months.
This variance of trading is more sophisticated and involves some deep thinking, study, and reflection. For most busy individuals, selling covered call options is the better route that allows time freedom from this in-depth study.
Just by engaging in this selling every month for a year can bring substantial returns, if formed as a regular trading habit with correct knowledge.
8. Dividend Income
This is where it gets really interesting. Getting portfolio income through selling options and also getting dividend income too, can result in paying some or all of one’s living expenses.
Begin small. If you have $1,000 to put into a $10 stock and can sell a contract to gain $25-$50 over a month, begin there.
You could earn and invest more money through having some kind of side work in the meantime. Once more portfolio income is made over time, less work is needed to support the lifestyle of choice.
With some work, having $5k to invest could mean an extra $200 passively gained through option contract selling.
And then there are the dividends, as a bonus on top of premium already gained.
For investors holding dividend-paying stocks, the combination of dividend income and premium income from covered calls can contribute to overall returns, especially during periods of market uncertainty. Even third, stock value increase may add even further to the gain.
Through picking stock that pays dividends, this third leg of the stool adds more income. Just be sure to own the stock when the actual dividend payment date arrives.
9. Tax Considerations
Taxes can significantly impact the overall net return. Profits from covered call writing are typically considered short-term capital gains, subject to higher tax rates. Understanding the tax implications is crucial for accurate assessment.
Perhaps as a beginning safety net, allow 25% of overall gain to be paid into taxes. The exact amount would be to be figured out before or at the appropriate time.
10. Diversification
Diversifying a covered call portfolio with different stocks and strike prices can help manage risk and optimize returns.
Owning 2-4 stocks with covered call option contracts may work great over time, provided a buffer against one or two going too far into the negative territory or companies lacking strength.
Be aware of the potential for some market crash also, as this may bring most to all stocks down in value. But through holding during this difficult period, the values should increase over the coming months as history shows. In any event, premium gained through selling does help to offset temporary loss.
It’s essential for investors to carefully evaluate each trade, considering potential returns, risks, and the investor’s financial goals. While covered calls can provide a regular income stream, investors should be aware of the trade-offs involved, including the possibility of giving up some upside potential in exchange for premium income. A well-thought-out strategy, disciplined risk management, and staying informed about market conditions are key to achieving a satisfactory average return from selling covered calls.
Leave a Reply