Selling Covered Calls vs. Trading Long Strangles: What Are Your Passive Income Goals?

Why do people decide to trade options? It can be a very dangerous and risky proposition for most traders, so why all of the love?

Options trading can be a lucrative wealth generator if you take the time to learn the ropes and create a system that works for you.

“The Options Playbook” discusses over 40 techniques that someone can use to build wealth. However, you will need to tailor your trading career to your emotions, finances, and time constraints. Today, I want to pit my two favorite techniques against one another.

The Perks of Becoming a Capitalist

A quick review. Selling covered calls consists of owning 100 company shares and selling the right for someone to buy these shares if they choose. You can read more about them in my article “Selling Covered Calls for Passive Income 2.”

Trading long strangles consists of buying one call option and one put option to “strangle” the stock price. You need a hefty price movement in either direction to earn a profit. You can read more about them in “Trading Long Strangles for Passive Income.”

As you can see, you are selling an option in one scenario, and in the other, you are buying two options. Each side of the coin offers its own win conditions and time constraints. The best way to understand time decay and volatility is to play with a small pile of money.

Money comparison. The most important difference between selling covered calls and trading long strangles is how much money you need to generate your desired returns.

Let’s start with covered calls. I use my rule of 40 to determine how much money we need in our options portfolio. To earn $500 per month in covered call passive income, we would need $20,000 (40 x $500) in our account.

Dividends vs. Royalties IV

For most people, $20,000 is a large amount of money; however, it is obtainable. The best way to envision saving that amount of money is to compare it to your job. How many hours would you need to work to earn $500 monthly?

If you earn $25 per hour, you would need to work 20 hours to earn $500. Setting up a covered call would only take you 15 minutes (tops). Would you rather sell a covered call or work 20 hours? That should be your mindset as you save $20,000.

Now, let’s look at how much we need in our account for trading long strangles. I use my rule of 15 for long strangles. To earn $500 per month, you would need $7,500 in your options trading account.

This is a massive difference between the two—what gives? To sell covered calls, you need to hold 100 shares of the underlying stock per call option. When you buy options, you control the 100 shares without owning them—what we call using leverage.

How to Control Your Spending 104

If I were you, I would focus on trading long strangles early on. The capital requirements are much lower, and selling covered calls still involves some risk. If selling covered calls were risk-free, it would be a different story.

Time requirements. How long does it take to set up covered calls? When things are going well, it takes three to five minutes. However, it can take a few months when things are not going well. What’s going on?

Selling covered calls boils down to focusing on your cost basis. Let’s say I own 100 Rivian (RIVN) shares at $10 per share. I want to ensure my strike price is over $11. That way, I earn the premium and $1 per share in profit if the price rises above $11. If it doesn’t increase, I earn the premium, keep the shares, and repeat the process.

But what if the stock price moves to $8? I am still in the stock for $10 per share. I must wait for some price recovery to sell covered calls. This can be quite frustrating, so you’ll want to prepare for these scenarios. 

Retirement Planning for the Average Person 6

If the stock price keeps increasing, you want to cool your engines. Chasing the price up while selling covered calls can leave you in a bad position if the price melts quickly.

I was chasing Palantir (PLTR) in the summer of 2023. I had ten covered calls as the price rose to around $25. Then, the price dropped to $18, and my cost basis was $22. I had to wait two months for the price to recover. 

That’s why you must be aggressive when using the options wheel’s other component—selling cash-secured puts. You want to obtain these stocks at the lowest possible price, so your cost basis is low when you start selling covered calls.

Conversely, trading long strangles can only take a few days to materialize. The best time to trade long strangles is around earnings calls, which are quarterly. Therefore, in order to earn your $500 per month, you would need to follow three stocks across three months.

Or you can earn $1,500 in one swoop against one stock. To earn $1,500, you would need to enter all $7,500 into the market at once ($3,750 in calls, $3,750 in puts). You would win if your options increased by 20% in combined value.

Treasury Bonds vs. Options Trading

But winning with long strangles is not guaranteed. The most likely way to lose is if the stock price doesn’t move enough in one direction to make you profitable. In this case, I get out with a loss and move on to the next one. Your mind will tell you to linger a few more days, which is usually futile.

Stress comparison. Which options trading technique is more stressful? It depends on how much you mitigate risk within your portfolio. If you are trading your entire portfolio at once, then they both can be quite stressful.

Let’s say you have $20,000 in your covered call portfolio. You purchase 1,000 Rivian (RIVN) shares at $20 per share. You can now sell ten covered calls (100 per contract), but you tied up every single penny under RIVN calls.

You sell ten covered calls and earn $1,000 in premiums ($100 x 10). The price moves down to $18, and no one can take your shares. However, your total portfolio reads $18,000 in stocks and $1,000 in premiums. Being down $2,000 in stock price can be quite stressful.

Trading Long Strangles for Passive Income

Now, we can reduce our stress by owning only 500 shares of RIVN and trading five call options. If the price decreases, we still have $10,000 in dry power to maneuver as we wish. The key is not to tie up every penny in the market at once.

The same goes for trading long strangles. If you have $7,500, you should only play with $2,500. When you play with $2,500, you should aim for a 20% profit, which is $500. Even if you lost all $2,500 at once, you would still have $5,000 to rebuild your portfolio over time.

Trust me, you don’t want all of your options money in the market at once—that causes the majority of stress in options trading.

How to Control Your Spending 103

Therefore, implementing capital controls on your trading can reduce most of your stress. If you are realistic with your win amounts (20% for long strangles), you have a much higher chance of coming out ahead.

As far as stress goes, it is considered a tie. You control the narrative around your trading account. Only you can create, implement, and adjust your portfolio size, trading limits, and winning criteria. 

Conclusion. I still have a lot more to write about selling covered calls versus trading long strangles, so stay tuned for part two.

As of right now, trading long strangles is winning in two categories (money and time) and tied in stress. Although trading long strangles is much riskier than selling covered calls, the amount needed is so much lower.

The Pros & Cons of Homeownership #2

As long as you place your controls against your total portfolio, you can build your account fairly quickly. Remember, you can only lose what you put in. If you have a $5,000 portfolio and buy $500 in options contracts, you can only lose $500.

Therefore, each time you trade, go with your gut. If a number seems too high, and you know that you would lose sleep if you lost, reduce your purchases for the week. Be flexible with your passive income goals, as you don’t want to stretch yourself because of some self-imposed guidelines.

You’ll learn that your emotions will change each time you trade. Circumstances in real life will affect how much you are willing to gamble. Trust your gut for both covered calls and long strangles, and you’ll be successful (by your standards). Stay tuned for part two. Good Luck!

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