Generating Weekly Income with Covered Calls
By: Chuck Hughes
The following is an excerpt from Chuck Hughes' Ultra-Safe Money Strategies
I have been very active selling option premium with weekly covered calls. Weekly options start trading on Thursday and expire the following Friday giving weekly options a six trading day life. Weekly covered calls are initiated by buying 100 shares of stock and selling 1 weekly call option. When you sell an option, cash equal to the option premium sold is immediately credited to your brokerage account. If you sell a weekly option with a 1.5 point premium, $150 in cash is credited to your brokerage account. This cash credit reduces the cost basis of the stock and reduces the overall risk of the trade.
The great advantage to selling weekly calls is that you get to sell 52 options every year! This has allowed me to compound my returns very quickly.
Options consist of time value and intrinsic value. At-the-money and out-of-the-money calls consist of only time value. At option expiration options lose all time value. If you are short an option, the time value of that option becomes profit at expiration regardless of the price movement of the underlying stock.
Time Value = Profit When You are Short an Option
For example, I own 1,800 shares of the small cap ETF symbol TNA. I have been selling weekly covered calls against my TNA ETF. I closed out 18 of the May 25 weekly calls and sold to open 18 of the TNA June 1st 49-Strike calls. The TNA ETF was trading at 48.43. My brokerage account shows that I sold the 18 TNA June 1st 49-Strike weekly calls at 1.47 points. After the commission, $2,628.31 in cash was credited to my brokerage account for the sale of the 18 options.
With TNA trading at 48.43 the 49-Stirke call is an out-of-the-money call consisting of only time value. At option expiration in one week, the time value of these options becomes profit regardless of price movement of TNA.
162% ‘Cash on Cash’ Return
Purchasing 100 shares of the TNA ETF at the current price of 48.43 and selling the 49-Strike call at 1.47 would cost $4,696 to initiate this covered call trade (48.43 – 1.47 = 46.96 x 100 = $4,696 cost basis). If you were to rollover this trade weekly and receive a similar premium you have the potential to collect $7,644 in cash over the next year. Receiving $7,644 in cash over the next year would result in a 162% ‘cash on cash’ return ($7,644 cash income / by original $4,696 in investment cost = 162%).
If you receive a162% cash on cash return a lot can go wrong and you could still profit from the trade. The underlying stock/ETF could decline substantially and you could still profit. If you had bad timing on entering the trade you could still profit. And there could be volatile price swings in the underlying stock/ETF and you could still profit. This gives the weekly covered call strategy a huge advantage over stock and option directional trades that require the stock or EFT price to move in the right direction to profit. Also, many times directional trades can get “stopped” out during volatile price swings if you employ a portfolio money management system.
With the TNA ETF trading at 48.43, the 49-Strike call option consists of only time value at option expiration. When you are short an option the time value portion of the option becomes profit as the time value decays to zero at expiration.
If the TNA ETF remains flat at 48.43 at weekly option expiration the 1.47 points of time value in the 49-Strike calls becomes profit as the value of the option goes to zero.
If the TNA ETF increases in price at option expiration you would still collect a 1.47 point time premium profit at expiration. The short option may show a loss if the TNA ETF increases in price above the 49-Strike price, but this loss is offset by an increase in the ETF price and you still wind up with a 1.47 point profit.
If the TNA ETF declines in price at expiration you collect a 1.47 point profit as the value of the short option goes to zero. This 1.47 point profit could be offset by a loss in the EFT price depending on how far the TNA ETF declines in price.
- If TNA remains flat at option expiration = $147 time value profit
- If TNA increases in price at option expiration = $147 time value profit
- If TNA decreases in price at option expiration = $147 time value profit (could be offset by loss in ETF value)
162% Return Potential Increases When You Rollover Options
I normally rollover my weekly options using an option spread order similar to the spread order we just discussed for the TNA ETF. If you receive a cash income of $147 each week and a total income of $7,644 over the course of a year, this income will allow you to purchase additional shares of the TNA ETF and make additional covered call trades. This would allow you to compound your returns and increase the 162% cash on cash return.
The weekly option covered call strategy offers very attractive returns and very low risk making this one of the best overall strategies for the average investor.