The other day I had a conversation with a client about our proprietary Layered Wealth(TM) strategy.
The conversation centered on income-producing assets and how we can use these investments to not only lower our tax bill but to cover our monthly expenses.
Part of the Layered Wealth strategy highlights investing in dividend-paying stocks. When we got to this part of the conversation, she asked if it really is possible to cover your monthly expenses by investing in dividend-paying stocks.
I told her yes and I shared the story of janitor Ronald Read. He’s not the only person.
Is it easy to make enough from dividend-paying stocks to cover your monthly expenses?
No. Is it possible?
Can it take a while?
But investing in dividend-paying stocks is just one part of the Layered Wealth (TM) strategy.
There are a number of other investments that can produce income and the cash flow necessary to cover your monthly expenses.
One of those investments is options.
Last week, we covered part I of the Options 101 series. Today, we’ll move on to generating income with options.
If you’re unfamiliar with Options or have stayed away from it due to what you may have heard, it’s worth taking another look.
There are a few ways to generate consistent income from Options. One way is by selling covered calls.
You may recall that a call option gives 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).
A covered call strategy entails owning the underlying security (for example, a stock) and selling calls on that stock.
Covered calls give the buyer the right to purchase the underlying stock at a set price and a specific time.
The buyer has to pay a premium to purchase the call.
Writing covered calls on the stock is essentially renting out your shares to another investor. Similar to how buying real estate and renting out the property for monthly income.
In order to write covered calls, you’ll need to understand:
Identify the Stock: you can either choose from the list of stocks you already own or purchase the stock and write calls on it. Remember every option contract represents 100 shares of the underlying stock so if you’re writing covered calls, you’ll need to own 100 shares of that particular stock. For example, if you own 510 shares of Exxon, you can write covered calls for 100, 200, 300, 400 or 500 shares (1, 2, 3, 4, 5) not for the full 505 shares. There are no fractional units or shares in option contracts.
Identifying the Stock to write covered calls: Choose a stock that has the potential for a big increase in the near future due to company news or a stock that is already at the target price you want.
The Strike Price: What price are you willing to sell your shares at before the expiration date?
The Expiration Date: When writing covered calls, you want the time between the date you write the covered call and when the contract expires to be short, either one week or one month at most. The more time that passes, the less value of the option contract.
The Premium Price: The premium is what the buyer of the covered call pays. As a writer of the covered call, you receive the premium upfront. This is one of the reasons covered call writers use that strategy. It’s also essential to the income strategy.
Let’s say you’ve owned a particular stock for a long time. You like the stock and think it has potential or there has been major news about the stock.
Rather than just holding on to the stock and waiting for the price to increase, you can write covered calls and generate income in addition to any increase in the stock’s price. You can do this on a weekly or monthly basis to add to your monthly passive income strategy.
Keep in mind that the buyer of the covered call option has the right to exercise the option so there’s a possibility that you will have to sell your shares before the option expires.
The advantage of the covered call strategy is that it limits your loss potential but you are also limited in the profit potential but it’s a great strategy if you want to generate weekly or monthly income.