As many of you know, our company has recently undergone a shift in approach.


We transitioned from being a strictly wealth advisory and have gone all-in on coaching our clients to invest for the lifestyle they want.


Investing for the lifestyle you want is all about investing for income.


We review potential investment opportunities primarily for income-generating potential or the ability to get our principal back quickly.


Over the last couple of weeks, we have shared in our Facebook group and in our weekly newsletter why you should invest in the lifestyle you want and ways to do so.


Let’s add one more investing opportunity to our cash flow arsenal, writing covered calls.


If those three words confuse you or you’re new to writing covered calls, keep reading because, over the next couple of weeks, I will give you a high-level overview of how you can use stock you already own to add to your monthly income.


Let’s begin with basic investing terminology and an intro to options.

 

Back to Basics

Stocks: When you buy shares in a company, you own a small part of the company. A stock is a unit of ownership.


Options: a derivative that’s based on an underlying asset. That underlying asset can be cryptocurrency, commodities, or stocks.


Options Contracts: Options are contracts between you and another investor. You are betting that a particular stock will go either up or down.


Options give the investor the right to buy or sell the underlying asset or instrument.


You are not obliged to buy or sell the underlying asset; you have the right.


Meaning, you can choose to buy the option, sell the options or do nothing and let it expire, depending on what is most advantageous to your position.


Options are either call or put. Call options give the buyer the right to buy the option (ex. the stock), 100 shares, at a specific price (strike price) by a certain date (expiration date). Note that the buyer has the right to buy, but they are not obligated to buy.


Option contracts usually expire on the third Friday of the month at 4 pm EST unless they are weekly options. They expire on Fridays.


Buying put options give the buyer the right to sell the options. Again, the buyer can sell, but they are not obligated to do so.


Strike Price vs. Current Stock Price

Earlier, I mentioned the strike price, which is the specified price of the option. You may be wondering what’s the difference between the strike price and the stock’s current price.


Sometimes, the strike price (the agreed-upon price of the option) and the current stock price are the same. This is called “At-the-money.” For example, if stock is trading at $50 per share, the option strike price will also be $50.


When the strike price is close to the current stock price, it is said to be “near-the-money option.”


When the strike price of the call option is lower than the current price of the stock ($45/$50), then the option is said to be “in-the-money.”


Lastly, if the call option’s strike price is higher than the current stock price, then the option is “out-of-the-money.”

 

Options Trading

Options are quoted per share but are sold in 100-share lots. Meaning, that if the investor purchases one option, they are buying 100 shares.


The investor only has to pay the option premium and not the total amount of shares like if you are buying per stock.


For example, if the option premium of a $50 stock is $3, the total amount of the contract is $300 per option.


So if the investor is buying three options at $3 per option, since they are buying in 100 share lots, the total payment would be $900 (3 options x 100 shares per option x $3 option premium).


How is this different from buying the stock outright?

Buying shares is different. You have to pay per share. For example, the stock price of Company A is $80.


If you want to buy 100 shares, you would have to pay $8,000.


Whereas with options, if you wish to invest in 100 shares, you have to enter into a contract wherein you would buy one option at a certain option premium.


If you wish to buy the stock at the end of the contract, that will be the only time you will pay the total amount of money equivalent to the number of option contracts multiplied by the contract multiplier.


If the buyer exercises his rights to buy the option (call), the seller (or the writer) is obliged to deliver the underlying asset. But don’t worry that you’ve sold your shares. We’ll learn about writing calls and generating income in our next installment, so you’re not just losing your shares.


If the buyer exercises his rights to sell the option (put), the seller is obliged to purchase the underlying asset.


If the buyer wishes to exercise his rights to buy or sell the underlying asset, the seller must either sell it or buy it at the strike price, regardless of its current price.


If the buyer of the option decides to do nothing at the end of the contract, the seller keeps the option premium as profit.


In evaluating your profit, you have to consider the option premium and the strike price.


If the option premium is $2 and the strike price is $50, your break-even point is $52.

So for you to make a profit, the stock must be more than $52. Going back to our earlier example, if the stock falls below $52, say $49, and there is no time left, you won’t lose $3 per stock. However, what you will lose is the option premium you have paid for the contract.


If this is your foray into options, don’t worry if it’s confusing. Re-read this whenever you have a few minutes until you understand.


Alternatively, contact us for a 1-on-1 investment coaching session.


In part two of our installment, we’ll evaluate how to generate income from options writing covered calls.

Writing covered calls is one of the more conservative approaches to investing in options and can be a great way to boost your monthly income.

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