Rental Income with Covered Calls

Covered Calls - Earn Rent from Stocks

If you invest in a rental unit, what will be your first concern? For most people, it will be how soon it can be put out to rent and how much rent will I get out of it? After all, everyone likes a passive income. Ask any rental unit owner, how much she likes the passive rent that she collects at the end of each month.

But, is it possible to collect rent from the stocks you own? Yes it is. Let me show you how.

Income Generation through Covered Calls

The options trading strategy you can use to collect rent from the stocks that you own is called Covered Calls. In this strategy, you sell out-of-money calls against the stocks that you own.

When you execute the covered call strategy against your long term stock portfolio, you benefit irrespective of the direction of movement of the underlying stock. The following cases may happen by the time of the expiry:

  • The stock moves down

You collect the call premium. You also reduce your cost of ownership of the stock as you have collected the call premium.

  • The stock remains the same

Just like the above case, you collect the call premium and you also reduce your your cost of ownership of the stock.

  • The stock moves up but not beyond the strike price of the sold call

In this case, you will still pocket the entire call premium. Also, your stock would have increased in value. Notice that while your portfolio value is increasing, your cost of the portfolio is coming down as you have collected the premium of the sold call.

  • The stock moves up beyond the strike price of the sold call

You will still profit in this case but your profit will be capped. Here, you will be called out and you will have to sell your stocks. You will sell your stocks for a profit as the strike price of your sold calls was more than the price of your stocks at the time of selling the calls. You will also keep the options premium. But here, you will not benefit from the movement of the stock beyond the strike price of the sold call.

The way to look at covered calls is that you have agreed to cap your profit on the stock that you own for the benefit of collecting a steady income every month. You can get around this limitation of putting a cap on your profits by choosing the strike price and expiry period well.

Selling covered calls regularly reduces your cost basis of the stock by giving you a nice, monthly premium. Covered Calls can be executed in many different ways. According to me, the most practical way to execute it is to sell out-of-money calls that are close to expiry. It is possible to generate 3 to 5% monthly returns selling covered calls. These returns, when reinvested can grow to a big corpus, thanks to the power of compounding.

Covered calls represent one of the easiest ways of collecting passive income from the stocks that you hold. In addition to that, it is practically risk free, when done against long term holding of stocks. This is one of my favorite strategies and I recommend that one must study it well and sell covered calls against her portfolio of stocks to collect a passive cash flow.

About the Author Gaurav Dhir

In my various avatars, I am an Options Trader, an Author and a Coach. I use Options Trading to create a source of passive income for my family and myself. I am also using the cash flow from Options Trading to create a long term portfolio of stocks. You can easily learn and replicate my methods, just go ahead and explore my blog.

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