Covered-call writing and cash-secured put selling can be used in conjunction with dividend growth investing to generate even more income in a portfolio.
By lowering our long-term cost basis, the rate of success will increase substantially compared to buying stock outright at market.
Conservative option selling strategies, known as covered-call writing and selling cash-secured puts on a monthly basis.
Dividend growth investing is by far the best opportunities which can help investors live off their dividends.
By selling options on stocks we’d like to own, we target annualized returns exceeding the 10% level in order to get sufficient premium while receiving a substantial discount if the shares are put to us by expiration. This helps not only reduce our cost basis, but we can benefit from a high IV rank which measures historical volatility against current volatility.
Selling covered calls combines upside potential, premium and corporate dividends we may receive along the way.
Some basics about options. Calls grant the owner the right to buy a stock at a preset price, called the strike price, up to a certain date. The cost of the option is called the premium, and it generally moves up and down with the price of the underlying stock. Options can last anywhere from minutes to months before they expire. One option contract controls 100 shares of stock.
A call is “in the money” if the market price of the stock is above the strike price. If the stock trades below the strike price, the option is said to be “out of the money.” If you sell calls against stocks or ETFs you own, you’ll immediately collect the premium, which you keep no matter what happens to the stock. Sell calls consistently and you’ll generate a steady income stream.
The main drawback of this strategy is that it caps your potential gains in a stock. If your shares get called away, you could miss out on profits in a fastrising market. Nothing would stop you from buying the stock again at the market price and selling another call. But you may owe capital gains taxes on the shares you sold. Option premiums are taxable as ordinary income.
That could be costly if you’re in the top federal tax bracket of 43.4%. And, of course, the premium you earn from selling a call may offer little consolation if the stock tanks.
The most challenging issue may be figuring out which calls to sell. One simple way to use the strategy:
- Sell actively traded call options
- Expiring in four to six weeks
- Strike prices that are 5% to 10% above the market price of the stock
- Premium of one percent to three percent.
The individual premiums may not amount to much—maybe one to two percent per share for a $50 stock. But selling calls like this every few weeks could lift your annual income by five to eight percentage points a year. The more volatile the stock, the greater the premium you’ll pick up with each sale (though you’ll face more risk that the stock will be called).
Keep in mind, you may have to give up the stock if the market bounces higher before your call contract expires. But aside from taxes you may owe on the sale, tha