“There are no bad stocks, just bad prices.” If you own an undervalued stock, or you’re waiting for an overvalued stock to correct, you can make money while you wait.
Provided you have enough cash to buy 100 shares of that stock, or you already own 100 shares, you can enter the world of writing options.
Pause. If you’re not familiar with options, watch this 10-minute overview:
Unlike shares, options eventually expire over time and become worthless (or worth loads). Options’ value is determined by the share price compared to the strike price of the option, the volatility of the stock in general, and how much time is left until expiry.
Hopefully, if you’re investing in anything other than an index fund, you understand what you’re investing in. If you’ve followed a company or industry closely, and you have a generally good idea about what their share price will do, then this strategy might be for you.
Might be. This ain’t financial advice, especially because you’re not paying me.
Are you expecting your shares to trade sideways (or even go down) but don’t want to sell them? Keep holding them long-term and instead write covered calls. You can make excess cash on your shares in the short term during periods when your stock’s growth is slow.
Covered calls are a type of option. Options are the fastest way you can lose money—when you’re buying them. We’re going to sell them instead (also called writing).
The opposite side of this is if you have cash but you think the current price is too high. While waiting for the price to drop, you can write cash-covered puts.
Say you own 100 shares of Tesla (FYI, you can only write calls on lots of 100 shares at a time). At time of writing, $TSLA is trading at $651/share. So with 100 shares, you own over $60,000 in Tesla. Nice.
You believe the price will stay below $700 for the next couple of months. You write (AKA sell) a call on TSLA with a strike price of $700, expiring at the end of next week. At time of writing, that call is worth $920 total, or $9.20 per share. If you pick a date further out, or a strike price closer to what the current share price actually is, the call will be worth more.
If you sell that call, then you have given someone else the right to buy 100 of your shares at $700 each. Technically, they can exercise that right anytime, but why would they exercise it unless the market price is over $700? If, at the end of two weeks, the price goes to $670 but no higher, then the options will expire worthless, you’ll keep your shares and the premium (the $920) for taking on the risk.
How do you make this work for you? There are two general ways to approach it.
Two Mindsets to Make Money Writing Covered Options
- Pick a price you’d be comfortable selling at. If you think Tesla is worth $700 and no more, then you’re happy even if the price goes higher because you’ll want to sell an overvalued stock anyway. This is the same as selling at $700, only you get a bonus for selling an option in the process.
- The other way is selling a call very aggressively at or near the price the stock is currently trading at. AKA selling a call for TSLA with a $650 strike price. This has a very good chance of exercising, AKA you will have to sell your shares. However, The premium would be juicy as hell. At time of writing, a $650 call has a premium of $2,733 per lot (100 shares). Even if you end up losing your shares, you’ll make $2733 in a week.
If you’re doing strategy #2, you can then turn around the next week and do the opposite of a covered call: sell a cash-covered put. That means you sell a bet that stock won’t go below a certain price.
You put up $65,000 as collateral. If the stock goes below $650 at expiry, you are obligated to buy 100 shares for $650 each. You’re back in the same place where you started. (because that’s what you sold them for) except you’ve made money in the short term by collecting premium. If you always set the price at or below what you sold your shares at previously, you won’t lose money.
For more info on strategy number two, Google around for “the wheel options strategy.” That’s the nickname.
Risks & Requirements
The only thing you’re really giving up when you do this is tax advantages. You have lower capital gains if you hold stock for longer than a year. If this is your concern, then only do it on shares you’ve held that long. But if you’re actively trading, this probably isn’t part of your equation anyway. You want to sell when the price is good.
Of course, you have to own 100 shares of a single stock to do this. The stock itself also has to have options available on it—and enough options. Some stocks only have options months out. Others, like $SPY, have options expiring every Monday, Wednesday, and Friday. Commonly, you’ll find options expiring and available every week.
Most options expire worthless. This is due to a combination of people buying options as a hedge, or using strategies like credit spreads (where they want the options they’ve bought and sold to both expire worthless), and also people are just dumb. I’ve bought loads of options hoping to get quick money that have expired worthless. I’ve also gained a bunch, so eh, what are you gonna do.
I comfort myself by remembering a saying from Jay Leno: “I’ve spilled more than you’ve drank.” After a quick Google, I don’t think Leno actually said this, but apparently it’s really common. Whatever, let me have this.
Make Money in Three Steps
Want to give this a try?
- Open an options account with Fidelity or someone else (you’ll probably need to get margin enabled)
- Pick a price you’d be comfortable selling at in general
- Write a call option and you’ll post your 100 shares as collateral. If your call gets exercised, you’ll sell your shares at the price you’re already okay with and collect premium in the process
What about moonshot stocks?
“But what if I think a stock will go parabolic sometime soon??”
If you find a stock with asymmetric upside, don’t sell a covered call on it. If 100 shares is all you have, and you’re afraid to lose it, then you’re not in the emotional position to write calls. Invest more, since you think that stock will go up anyway, and then write calls on it once you have enough “extra.” That way, if your call is exercised, it won’t totally break your heart because you’ll still have some shares.
Covered calls are a great way to collect premium and make some petty cash when your favorite stock is trading sideways. The more volatile the stock, the higher the premium. But if you’re willing to stomach the drops, have your shares called away, and have enough shares to even get started, then this is a killer way to invest your cash and make money on your investments at the same time.
Random Tips I’ve Learned from Doing This
- The more fear you have, the more you need to raise your strike price
- If you have multiple lots of the same stock you’re selling, reduce your risk (and your profit) by selling at different strike prices
- If you’re sitting on a stock that’s particularly volatile, and you’re afraid a random piece of good news might send it to the moon, then buy yourself some moon insurance with a very very far OTM (out of the money) option
- You’ll reduce your profit when you buy options at the same as selling them, but if it gives you peace of mind because you genuinely think it’ll 5 or 10x in price in a short amount of time, then this might be worth it if it means you’ll actually sell covered calls and make money in the short term
- I love the covered call strategy because it also provides a modicum of downside protection. If the stock you love suddenly plummets, not only have you made money because of the plummet (your shares won’t be exercised and you’ve collected premium), but now you have cash to actually purchase more shares at a discounted price
Good luck! Remember, not advice. Be dumb on your own.