If you were to listen to Warren Buffett, the best way for an ordinary Joe or Jane to invest is to allocate a fixed amount of savings to an index fund each month.
The market ups and downs may make you feel on top of the world sometimes and down in the dumps at other times. But if you can ride the stock market swings without selling any holdings in your lazy portfolio, your regular contributions may produce a handsome nest-egg in the long run.
The passive investing approach is appealing to hands-off investors who are happy with a fixed dividend yield and the upside from rising share prices. But is there a way for investors who want a little extra cash flow to make even more money?
Just like an investment property owner who makes money from tenant payments, so too can shareholders earn a regular yield from owning stocks.
And we’re not talking about dividend yield, although that would be a bonus!
To make extra money from stocks you already own, you can do what investing maestros do: sell covered calls.
If you have never bought or sold options before, you may not be familiar with a covered call but it is one of the most powerful stock and options strategies any investor can employ.
Here’s how it works.
Imagine you own shares of a company that have risen in price. You don’t want to sell the shares because they may go higher. But equally you don’t feel especially confident the shares will move much higher.
In this situation, you can sell call options against your shareholding.
The strategy locks you into a simple agreement. If the share price were to rise above a certain price level by a fixed date, you agree to sell your shares at that level.
However, if the share price doesn’t end up above that level by a certain date, you are not obligated to sell your shares.
How To Use Covered Calls In A Lazy Portfolio
Seems like a bum deal.
Why agree to sell your shares at a fixed price by a certain date?
After all, if you don’t make the agreement, you can continue to make money as the share price goes ever higher.
The short answer is you get paid when you make the agreement. And sometimes, you can pocket a handsome amount.
In fact, selling calls against stocks you own may not lead to a mountain of riches in one month or two, or even three. But over the course of one year, or two or three years, regular income from selling calls can add up to much more than just pocket change.
A short-sighted investor may spurn the idea trading covered calls by enquiring:
“Why make only 0.5% → 1% per month from selling call premiums when I could make 10% this month if the stock rallies higher?”
If the stock were to rally a lot in a short time period, you might indeed be worse off by locking yourself into a deal where you are forced to sell your shares at a lower price point.
But what are the chances the share price will increase by 10% each month?
The reality is even stocks like Amazon, Facebook, and Alphabet will have roller-coaster rides in share price over time.
So rather than evaluate the merits of the strategy over the short-term, it is best to crunch the numbers over the long term.
How Much Can You MakeTrading Covered Calls?
When you calculate the premiums you can earn from selling covered calls against your shares on any given month, they may seem flimsy.
You may not be able to make much more than 0.5% on any given month.
But hang on a moment.
If you could earn 0.5% every month for a year that’s a 6% annual return… which beats the savings rates available at most banks.
Generally, more volatile stocks will pay higher covered call premiums. So, selling call options on a stock like Netflix may offer higher premiums than those on a stock like Microsoft.
Nevertheless, it is usually not a smart idea to buy a stock just for the premium you can earn from selling calls.
After all, if you are looking to sell calls for extra cash flow, you are probably searching for income. And so you may wish to avoid a wild ride of share price gyrations on a volatile stock.
But that’s okay, you may still be able to earn a handsome annual yield selling calls on so-called “boring” blue-chip stocks.
Add in a quarterly dividend payment from these stodgy stalworths and you’re talking about some potentially lucrative cash flow by year’s end.
Now your lazy portfolio can make money from call premiums and dividend payments.
What Covered Calls Make Most Money?
Selling calls for cash flow requires you to balance greed and fear.
If you agree to sell your shares near their current price point, you will enjoy a higher call premium.
On the other hand, if you are only willing to commit to offloading your shares when the price rises significantly, you will earn a smaller call premium.
Conservative investors may be willing to agree to sell shares at prices closer to the current price so they can lock in higher premiums while risk-seeking investors may be willing to gamble on higher share prices at the expense of lower call premiums.