I have been trading covered calls for a while now, and it has been serving me well. It allows me to hold onto my long term investments, with an extra periodic payment thrown in as a welcome bonus. The catch? I limit my upside during that period that the option is live.
I look to generate between 0.5-3% a month on my holdings depending on their levels of volatility. As you can imagine, this ends up making a significant difference over an extended period of time. Please note, this does not mean that your downside is protected. You are still able to lose your whole investment if the underlying you hold goes to zero.
I believe an example would help us here.
Let us play pretend, and imagine that I was someone with a certain investment view over the next decade. Perhaps I believe that the world will now move towards a new energy infrastructure and ecosystem that is more electrified. With such a view, I would perhaps be looking to invest in the following:
Solar companies (renewable energy generation)
Copper mining companies (raw materials needed to upgrade the grid for electrical transmission)
Electric vehicle companies (hopefully discharging carbon free electrons rather than burning carbon molecules)
Here are charts of some of the ETFs that represent these ideas:
Check the Y axis for prices over time. What do you notice about these investment vehicles? For me, it screams VOLATILITY!
The KARS ETF went from $19 to $55 and back again in less than 4 years. That means one would have gone from driving a corolla to an electric lambo in 2 years. It is now 2024, and if said investor was not properly hedged or over-levered, he might find himself kicking some used prius tyres in a used car lot while reading this.
Enter covered calls.
So what is a covered call? According to investopedia:
So in essence, you own an underlying security, and you make an extra income from premiums of options sold against that security.
”Simply put, if an investor intends to hold the underlying stock for a long time but does not expect an appreciable price increase in the near term, then they can generate income (premiums) for their account while they wait out the lull.
The maximum profit of a covered call is equivalent to the premium received for the options sold plus the potential upside in the stock between the current price and the strike price. Thus, if the call is written with a strike price of $100 on a stock trading at $90, and the writer receives a premium of $1.00 per stock (100 stocks per options contract), the maximum potential profit per stock is the $1.00 premium plus a $10 appreciation of the stock—or a total of $1100.”
So what does this have to do with Tesla and volatile copper mines in Panama you say? Remember our 3 different ETFs listed above. Putting them into the options premium calculator over at premium.coverd.io:
As you can see, these ETFs currently generate between 0.8-3% a month in premiums, with the catch being that the investor’s upside for his underlying asset is capped at 10% between now and the option’s expiry date 7/19/2024 in this case. This post was drafted on the 24th of June, before markets opened.
Assuming these rough premium values stick over a multi year horizon, and assuming these underlying assets (TAN, COPX, DRIV) continue to thread water violently without going to zero, the investor would be looking at ROI’s in the 20% per annum range approximately. THAT IS NOT TOO BAD, being able to get paid to wait for an investment thesis to work out.
In general, the more volatile an underlying asset, the higher the premiums associated with said security.
So is the covered call strategy for you?
This is just a brief intro to the topic, with tons of more indepth content out there for the curious investor.
Thanks for reading, and good luck with those investments. Disclaimer: This is not investment advice, and please do your own research. I am currently in a used car lot kicking tyres. Bicycle tyres.
Extra Resources
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