Those of us on a quest for extra income may find it in an unexpected place – your current portfolio of stocks. The way to get this extra income is by selling covered call options over your stocks.
Think of real estate…. If you own real estate, would you rent it out or leave it vacant?
No doubt you’d rent it out. Why on earth would you leave it vacant? Why would you want to miss out on that rental income each month?
So what about shares that lie idle in your portfolio? If you own shares why not rent them out. Think of the potential income that you are missing out on each month.
The concept of renting shares is to potentially earn monthly income from selling someone the right to buy your shares from you for a price you are happy to sell them at. This strategy is known as “Writing Covered Calls” which is an easy-to-use option trading strategy.
For the purposes of this article, let’s assume we have a stock portfolio of conservative stocks, e.g., ANZ, BHP, etc. We may be realising a moderate price appreciation in the order of 4 to 5% annually plus dividend yields of around 5%, for total portfolio growth of around 9 to 10% annually.
One easy way to boost our annual gains without increasing our downside risk is to sell call options against our stock holdings. A Covered Call is created by selling the appropriate number of call options against stock in your portfolio.
Let’s assume we own 1,000 shares in ANZ. It closes at $25 on the 31st March 2010.
We are concerned that ANZ may trade sideways or only slightly upward for the next month. We could sell the following covered call option:
Sell 1 contract of the ANZ April $26.50 calls for 0.60 cents, or $600 per contract.
This would generate you $600 or $500 after costs which is deposited straight into your CMT account.
If ANZ closes at any price less than $26.50 on the 29th of April 2010, the calls you sold expire worthless and you keep the $600. The income received for this represents a 2.4% return on our investment in ANZ. However, if ANZ rallies to any price above $26.50 by April 29, our stock will be “exercised”, i.e., whoever bought those calls that we sold, will get to buy our 1,000 ANZ shares for $26.50.
In this case you still get the chance to sell your ANZ shares $1.50 higher than where they were at the start of the month.