If you want to retire in America, you must build a stream of passive income. There are many ways to generate income in your sleep; however, understanding these streams is vital to building wealth.
Two ways to generate a return on your invested money are selling covered calls and investing in dividend stocks.
Both options offer advantages and disadvantages, so combining both will maximize your returns.
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Investing in dividend-paying stocks. I am a massive fan of dividend investing. I use two methods to invest in dividends: dividend growth investing and income investing.
Of these two methods, I prefer income investing, where I aim to obtain a 10% return on my invested capital in the form of dividends.
Over the last five years, I have built a portfolio that pays me $2,000 monthly in dividends. I love waking up to see more money in my account than when I went to sleep.
Selling covered calls for passive income. If you like a little more risk, trading options can juice your returns.
Calls are a form of option contracts where you predict that the price of an underlying stock will move upward. For example, if the cost of AT&T is currently $17, you can buy or sell a “call option” with a strike price of $18.
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One call option contains the right for the owner to purchase 100 shares of the underlying stock if the price increases past the strike price. The owner has the right to purchase those stocks but doesn’t need to exercise that option.
Selling covered calls is a safer form of trading options. In this strategy, you own 100 shares of the underlying stock. You sell a contract to a counterparty that gives them the choice to purchase your shares if the price increase passes the strike price.
For your efforts, you will receive a premium for selling your contract. You keep the premium whether the counterparty takes your 100 shares or not. In a perfect world, you could keep reusing the same shares while collecting a new monthly premium.
Covered call vs. dividends. Now, let’s get to the meat of the situation. Which method is best for generating passive income?
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Dividends are the most passive form of passive income available to the average investor. You put your money in, and the company sends you the dividends.
However, you will need to have a massive portfolio to generate any meaningful type of income. For example, at an 8% return, you’ll need $100,000 to generate $8,000 in revenue per year.
Selling covered calls can help you generate 2-3% monthly returns. However, you are taking on more risk and more responsibility.
The best part of selling covered calls is that you can create passive income from growth stocks that normally don’t pay dividends.
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Creating passive income from growth stocks. Most people prefer investing in growth stocks like Tesla (TSLA), Nvidia (NVDA), and Palantir (PLTR).
The average consumer believes that being rich (from capital gains) is more appealing than being wealthy (from cash flow).
This reasoning is why many young investors flock to speculative growth stocks and cryptocurrencies. Selling covered calls allows these investors to generate monthly income from their growth stocks.
Let’s explore selling a covered call using Palantir (PLTR) because it is the most affordable of the above-listed stocks. Palatir’s current stock price is $21.17. If I were to purchase 100 shares of PLTR today, it would cost me $2,117.
Looking at the above chart, I can sell a covered call using my 100 shares for $0.85 per share. The expiration date is a month away.
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The total premium I could collect would be $85 ($0.85 x 100). That’s not a bad haul for my $2,117 invested capital.
If I could replicate that $85 every month, it would come to an annual interest rate of 48%. However, this is where things become tricky.
When selecting the $0.85 option contract, I chose the one most likely to be called. The stock price must rise only a couple of cents to cross over the strike price.
If I wanted to reduce more risk, I would choose the $0.39 call option at the strike price of $23. If my shares were called away at $23, I would take significant capital gains with me.
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The $39 premium at the annual rate is 22%, which is still better than income investing. The good news is that I generated a 22% return from a growth stock that doesn’t pay dividends.
Dividends to the rescue. You have a lot of choices when selling call options. You will face your “fear & greed” reflection in the mirror every month.
Now, let’s see what happens if I invest that $2,117 in a high-income, monthly-paying closed-end fund like Eagle Point Credit (ECC).
ECC is a closed-end fund that invests in Collateralized Loan Obligations (CLOs). The CEF invests using leverage and purchases leveraged loans. It offers high risk and high rewards for investors.
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The good news is that someone else (a professional) does all the wheeling and dealing to earn their returns. All I do is sit back and collect my monthly dividends.
The current price for ECC is $10.27, and it pays a monthly dividend of $0.16 per share. I can purchase 206 shares, which would pay me $32 per month.
This would pay me $384 per year at an annual rate of 18%. It’s important to remember that ECC and other closed-end funds are not for the average investor.
However, investing in ECC requires much less risk than choosing your own call option premiums. It is “fire and forget.”
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Putting it all together. Selling covered calls allows you to juice your returns by choosing riskier plays each month.
Investing in closed-end funds and other income-investing products can match the returns of “safer” options trading.
If you invest in dividend growth companies like McDonald’s (MCD) and Starbucks (SBUX), you will receive your returns via dividends and capital gains.
You can even get brilliant and sell covered calls using your dividend growth stocks. Now, you can collect the options premiums and dividends while watching the stock price grow.
What is Your Investment Philosophy?
Conclusion. I personally become really attached to my dividend-paying stocks. I would hate to watch someone take them away while selling covered calls.
I’d rather sell covered calls on growth stocks whose only purpose for me is to generate more passive income.
If I like a long-term prospect of a growth stock like PLTR, I purchase shares in my STASH account and don’t use them to sell covered calls.
Ultimately, building wealth is about knowing all the choices available to you. Very few people can make their money earn more money.
Even if you aren’t a big options trading person, learning how to trade them is a good idea. You may need to use them at some point, and knowing how to leverage capital will make you a proficient capitalist! Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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