Although I mainly invest in LEAP Options (hoping for larger returns), I see cover calls as a consistent means of getting a higher return with less risk. You might also know that I am 100% completely against rentals, and a large reason is why is because of cover calls. Note: For those who do not know, cover calls are a situation where you own the stock and sell options against your stock.
You might buy 400 shares of Home Depot for $73.90 and sell four options for Oct 13 @ 67.50, giving you a premium of $7.00 per contract. That means your $29,560 investment (stock) will give you $2,800 in premiums (4 contracts * $700) for the right to buy the stock at $67.50 in the next 45 days. You have to take out inherit value to see the actual net return: ($73.90 – $67.50) * 4 = $2,560 of inherit value.
Therefore your $2,800 of premiums breaks down as follows:
- $240 net (0.81%)
- $2,560 (8.66%) of downward protection
In this scenario it is assumed that the stock will be “struck,” and that you will lose your stock (which you can absolutely re-buy immediately), but you made close 1% in 45 days with a GIANT downward shield. It would take a lot of bad news and earnings to drop over 8.66% in the next 45 days, heck this stock hasn’t even touched $67.50 in about 6 months.
If we turn that $240 into a monthly return, it’s $160 a month. You are netting $160 with very little risk (Don’t forget that downward protection refreshes every 45 days). That’s $1,920 a year on your $29,560 (6.5% return).
Less Downward Protection (Less In the Money):
If you are willing to reduce your downward shield from $67.50 strike to $72.50, your return jumps $700 net (2.36%) with a shield of just $1.40 a share (1.89%). That translate into $466.66 a month or $5,600 a year on your $29,560 (18.9% return).
Of course it’s your decision on how much protection you want (that is determined on how bull/bear you are in general), but the points remains it’s very easy to get a couple hundred dollars a month with pretty low risk. Which brings me right back to rental property. Why in the world would I go buy a rental property and put down that same $30,000 and fight an epic battle just to TRY to net a few hundred dollars a month? The only logic in that situation is that you believe the housing market will appreciate, and if you are betting on another housing bubble then this conservative strategy really wouldn’t appeal to you anyhow.
Just think about the big picture, you are effectively buying the cash flow of a rental for it’s down payment cost, with no virtually no hassle and no surprises. You want want real passive income? Then get $500k and start writing cover calls for for .7% to 1.0% a month, you will be clocking in $3500 to $5000 a MONTH ($42,000 – $60,000), that’s true financial freedom.