The good, the bad, and then what do I do? The good is our loan rates on our debts are low. It is funny to hear a mortgage rate of 3.5% could be high. The bad is our income-based investments are not paying very much income. If you are retired and depend on investment income, you are indeed feeling the stress. So, what do I do? That is the question we keep getting, and it is not an easy answer. However, some strategies can help. Let us discuss the covered call strategy.
What are covered calls?
Let us start by defining the term covered call. Covered means you own the stock. A call is an option contract that provides the right to purchase the stock. Each call contract is for 100 shares of the stock. Let us look at an example.
If you sell five call options to buy your stock at $32 and the contract expires in 25 days, you are paid $125 immediately for the contract. After 25 days, one of these three scenarios will happen:
- The price of the stock has gone down.
- Result: You keep the premium income, and the option to buy your stock will not be exercised. We would likely sell a new contract to repeat the strategy.
- The price of the stock has not changed.
- Result: You keep your premium income, and the option to buy your stock will not be exercised. We would likely sell a new contract to repeat the strategy.
- The price of your stock has “taken off.”
- Result: You keep your premium income, and the option to buy your stock will be exercised, proceeds will be deposited into your account at $32 per share. We would then purchase another stock and sell a new contract to repeat the strategy.
So why are we using this strategy?
Income! We have found income in an environment of minimal income. Now in your portfolio your fixed income will be paying some interest, and on the equity side of your portfolio we have found a way to add an income-producing strategy.
Use this link to see a short video that illustrates how this strategy works. Covered Call Overview Video