Retirement Communities Blog

It is amazing to me that not many retail investors understand the concept of generating cash flow from their stock positions. When I tell people that I utilize covered calls to generate extra income, hedge my stock positions, and set strict sell disciplines they look at me like I am crazy. I was introduced to the concept by several of my clients. They explained the concept to me. The idea of writing covered calls is the only option strategy that you can employ at most of the major brokerage firms for your IRA investments. The reason is that writing covered calls is a very conservative strategy relative to other option strategies.

The strategy is very similar to selling an option on a piece of real estate. For example, I’ll give you $10,000 now, if you allow me to buy your property 6 months from now at a set price. If I choose not to exercise my option, you keep the money and we go our separate ways.

With a stock, if I buy 1,000 shares of ABC OIL at $10 and the stock goes to $11 in the following month. I can sell someone the “right” or option to buy the stock from me six months from now at $12.50. For that right or option, the option buyer has to give me some consideration, similar to the above real estate example, let’s assume it is .50 per share or $500.

The $500 is immediately deposited into my brokerage account, but an option position also shows up on my statement. I must keep the stock for the whole term of the option contract unless I buy back the option on the open market. Therefore, I typically hold my stocks until expiration.

Six months from now, two things can happen. One, the stock goes above $12.50 and the person “calls” me out of the position, which I am more than happy to do since I bought it at ten. Second, the stock has declined below $12.50 and the option holder is holding on to a worthless option. The option holder would not “call” the stock from me at $12.50 when he or she might be able to buy it in the open market at $11.50.

Then I start the process again by writing new covered call options.

Let’s examine what I accomplished with this strategy: 1. I hedged my position by 5% or $500 2. I set a strict sell price that I was willing to let the shares go for, $12.50 3. I generated income that I could enjoy or reinvest.

This strategy has made me extremely happy since the stock market has declined. Covered call options helped me to remain profitable even in this recent bear market.

As a reminder, make sure you “know what you own” and consult with a tax professional or adviser before investing your hard earned money!