How To Use CALL Options For Income Generation

We’re back for part 2 on how you can generate monthly income using PUT options. This time, I’ll show you how to use CALL options to generate income. If you have not read part 1 of this article, you can do so here.

To recap, options is a contract between the buyer and the seller based on an underlying asset. These assets can be commodities, ETFs or Indices. In order to generate income, you must be an option seller.

In the previous article, I talk about cash secured PUT options and how you can use it to buy stock at a discount or generate monthly income. Let’s explore the second strategy:

Covered CALL Options

This strategy is a continuation from the 1st strategy – scenario 2 where you are obligated to buy 100 shares of Adobe at strike price of $450. Once you owned 100 shares of Adobe, you can then sell CALL options.

When you sell a CALL options, you promised to sell 100 shares of Adobe at an agreed strike price and within a specified date of expiration. In return, you receive a premium. If you do not own 100 shares of Adobe, then you cannot use this strategy.

Let’s continue from the previous article’s 2nd scenario where you bought 100 shares of Adobe as a result of selling PUT option. So, now you have 100 shares of Adobe and you intend to hold until the share price goes up to your target price.

Instead of waiting the price to go up, why not generate income while waiting the share price to go up? You can do this by selling a CALL options with a strike price = your target selling price.

Let’s say your target price of the stock is at $700, so you sell a CALL options at this strike price with a 30 days expiration. The premiums that you’ll receive would be $10. Below is the summary of the contract:

Option TypeSell CALL
Underlying AssetsAdobe
Strike Price$700
Contract Size100 Shares
Days to Expiration30 Days
Premiums$10
Total Premiums Received ($10 x 100 Shares)$1,000
Initial Position [($450 - $10) x 100 Shares]$44,000

There are 2 scenarios as well from selling this CALL options:

1st Scenario – Adobe stock price stays at $450 or below at expiration date

Again, there’s nothing you need to do here because the option contract now has expired worthless and you keep the premium of $1,000 – income to your pocket. Your ROI from this is 2.2% ($1,000/ $45,000 x 100).

You can continue to do this every month collecting $1,000 and in a year’s time you would have gained an ROI of approximately 26% simply by selling CALL options on Adobe. Of course, this is provided that Adobe’s stock price continue its sideways movement and stays below your CALL options strike price. What happens if it goes above $700 strike price? See below.

2nd Scenario – Adobe stock price went up above $700 at expiration date

You now have the obligation to sell your 100 Adobe shares at $700 per share which you would happy to do it anyway. Because when you sell at $700, you are already making a profit as your initial costs per share is $440. Based on this, your ROI is as follows:

Initial Position [($450 x 100 Sh) - Premium received from selling PUT]$44,000
Total Premiums received from selling CALL ($10 x 100 Shares)$1,000
Selling Price as a result of CALL options exercised by buyer$700
Total Sales Proceeds ($700 x 100 Shares)$70,000
Total Profit (Sales Proceeds - Initial position + Premium received from selling CALL)$27,000
ROI ($27,000/ $44,000 x 100)61.4%

Once you’ve sold your 100 Adobe shares, you can repeat the process again using the cash secured PUT strategy. This is how you generate monthly income by constantly using both of these strategies.

My Insights on using CALL & PUT Options

Both Cash Secured PUT and Covered CALL strategy can only be done on stocks that are of great fundamentals.

But usually stocks that has great fundamentals are priced higher. This leads to the requirement of a bigger starting capital in order to deploy this strategy. Case in point, Adobe which requires you to have at least $45,000 in your brokerage account.

There are many other option strategies which does not require such huge capital. Personally, I use credit vertical spreads and calendar spread. These 2 strategies provide a higher return with lower capital requirements.

If you find this article interesting and want to learn more about it, we do have an option course coming in April 2021 for a price of only RM299 per person. You can register your interest here – https://forms.gle/hzjNGGHjYvrHPHrM6

If you would like to receive more articles about Investing 101, do subscribe to this website. You can also check out some of my past articles on REITs or get some investment ideas by browsing through my articles on companies analysis.

DISCLAIMER: The above mentioned stock or derivatives is NOT a recommendation to buy or sell but merely for education purpose. You should do your own due diligence on the mentioned companies before making any investment decision. The author is not liable for your profit or losses made out of your decision to buy or sell.

Thomas Chua
An equity investor and co-founder of Stocks Insights. Prior to this, he was attached with medium-size audit firm for 2 years working as an external auditor where he have performed statutory audit on companies from various industries including oil & gas, retailers, manufacturing, industrial products & machinery, etc. He is also involved in Enterprise Risk Management exercise and the internal control framework review for entities undergoing a listing exercise on Bursa Malaysia and SGX Catalyst Board.

Related Articles

LEAVE A REPLY

Please enter your comment!
Please enter your name here

Latest Articles