Selling Covered Calls for Passive Income 2

Selling Covered Calls for Passive Income 2: Why Take the Risk?

What’s not to love about earning passive income? You invest your money, go to the beach, and your accounts grow with magical passive income. Right?

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That’s the fantasy, at least. In reality, creating a passive income stream requires hard work and specific knowledge. Today, I want to focus on one way to earn passive income: selling covered calls on the options market.

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What’s your passive income goal? I have many articles about selling covered calls, so I’ll focus on something more personal: what’s your dream retirement?

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I ask you this because you’ll fail in the options market without a powerful enough dream. There is no reason to trade options if you simply want to rot away on social security.

However, consider trading options if you imagine retiring in foreign lands or fancy hotels. For example, in 2023, my wife and I traveled to Istanbul, Turkey, for three weeks. While there, I earned $4,000 in passive options trading income, which was enough to fund the entire trip. 

If you have big dreams, passive income can help you achieve them. However, the road to success can be treacherous, which is why most people don’t trade options.

Why covered calls? Selling covered calls plays a specific role in your passive income portfolio: volatility. The goal of trading options is to harness the volatility and convert your earnings into true passive income. Let me explain. 

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It’s tough to say that I will always earn $500 per month in passive income from selling covered calls because the market is unpredictable. The premiums you earn depend on the timing and volatility of the underlying stock.

Let’s say you own 500 shares of Palantir (PLTR). One month, you sell five covered calls and earn $300 in premiums ($60 per contract). Next month, it may be $500, and the following month, it may be $200.

But one thing is for certain: Selling covered calls will generate more revenue than keeping your money in a high-yield savings account

The importance of doing math. The most essential part of trading options is doing the math. For every trade you make, you must calculate your annual yield. Performing this step will tell you how powerful your trade is compared to other risk assets (income-producing assets).

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Let’s say we have 500 shares of Palantir (PLTR) with an average cost per share of $20. We sell five covered calls at the strike price of $21 and net $500 ($100 per contract). What is our annual yield on this trade?

To find the annual yield, multiple your premium by 12 months ($500 x 12 = $6,000). Now divide $6,000 into the total amount of underlying assets ($10,000 of PLTR shares). The annual yield is 60% ($6,000 / $10.000).

You’ll be hard-pressed to find another way to earn 60% returns safely from the comfort of your own home. Let’s examine another possible outcome that may be even better.

Here’s an even better case: Let’s say we bought PLTR at $18 per share and sold five covered calls at the strike price of $23. The price shot up to $24, and on Saturday morning, someone took our shares, and we had $11,500 in our account. Let’s do the math on this.

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Our initial capital for 500 PLTR shares at $18 is $9,000. We earn the same $500 in premiums. We also have $5 per share in capital gains, totaling $2,500. Our net profit from the trade is $3,000, with an annual yield of 400%.

You can’t expect to hit the jackpot like this very often, but it can happen. But you can also lose. How do you lose when selling covered calls?

A worst-case scenario. You lose when trading covered calls when you get anxious, impatient, or greedy. Simply, you trade when your cost basis is higher than the strike price. Let me explain.

Let’s say you own 500 shares of PLTR with a cost basis of $27 each. The current stock price is $23. The good premiums hover around the stock price so that the best strike price will be $24.

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You can actually take the risk and sell covered calls at the strike price of $24. I have done this trade before; it is nerve-wracking. You know you will lose $3 per share or $1,500 if the price exceeds $24. This is not somewhere you want to be—avoid this position at all costs.

How do you avoid this position? You wait for the price to recover. If you trade decent, young stocks, the prices will eventually recover. However, sometimes it may take 2-3 months.

People get into trouble by not being patient and waiting it out. You should diversify your trading to include more than one stock. Currently, I like Palantir (PLTR), Rivian (RIVN), SoFi (SOFI), and Draftkings (DKNG).

Putting it all together. So why take the risk at all? Why sell covered calls when you can earn 5% with a high-yield savings account, treasury bill, money market fund, or certificate of deposit?

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First, you cannot depend on the federal government or banks to protect savers because interest rates will not always be this high. 

Second, you must learn to leverage the free market economy to become a capitalist. I can look at the stock market today and know that SoFi is historically low (over the last two years) at $6.50 per share.

I can purchase 200 shares and sit on them. In a few months, the price may recover to $8 per share, and I can sell amazing covered calls—all because of the knowledge I created.

Do not underestimate the ability to make money at all times (bull and bear markets). If you love trading options and selling covered calls, you can even go full-time.

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Third, the ability to make money from anywhere in the world. Imagine waking up in Lisbon, Portugal, earning $1,000 from selling covered calls. That may be enough to fund an entire month’s worth of entertainment and fun.

Trading options to give you options. Ultimately, selling covered calls gives you the ability to choose your lifestyle. Do you want to depend on a W-2 employer for all your income?

Depending on your job as your only source of income is risky, especially with artificial intelligence making its way to a job near you.

How many people can consistently earn $100 per month outside of a W-2 job? The answer is not many.

The first step is finding your dream retirement and slapping a financial bill on it. Let’s say you want to earn $10,000 per month in retirement.

From there, you can start to calculate your passive income streams: social security ($3,000), dividends ($2,000), and renting rooms ($1,000).

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Conclusion. I use the rule of 40 when setting up covered calls as an income stream. My rule of 40 states that you need 40 times the amount of your anticipated monthly options income.

For example, to earn $1,000 monthly, I need to have $40,000 in my options trading portfolio. That ensures I can purchase enough shares to cover my monthly amount in premiums.

For example, today, PLTR shares sell for $32.68. I can purchase 1,000 shares for $32,680. I can sell ten covered calls for $1.66 per share, giving me $1,660 for a one-month contract.

The difficult part is saving $40,000 in addition to your emergency fund, retirement savings, and dividend portfolio. I recommend getting a roommate to accelerate your savings rate.

Selling covered calls isn’t for everyone, but it is for those who want more from life. Once you get the hang of it, losing money is tough. You just need the patience not to trade when you are underwater.

If you have a big dream for retirement, selling covered calls can play a massive role in your future. Very few people on Earth can leverage their money to make more money. 

Most people let someone else tell them how much they are worth. Will you let someone else control your income stream? I won’t. 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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