How to Use Covered Calls For Income (2020)

hi this is Matthew Crowder from trader university and today I want to show you how to use covered calls to generate income in 2020 if you're interested in learning investment strategies or trading strategies to make money both in a bear market and in a bull market be sure to hit that subscribe button so then one of the questions I get I'm always getting from my subscribers is how to generate income in these very low interest interest rate times so if you're storing your money in a savings account you're really lucky if you're making one or 1.3% these are some high-yield savings accounts and so I'm going to show you a wave using covered calls as sort of a substitute for this now obviously none of this is an investment recommendation stocks can go down they're more risky than savings account savings accounts but I'm going to show you a fairly conservative way it's considered the most conservative options trading strategy if you don't know anything about call options be sure to watch my video from a couple days ago I'm gonna link to it in the description notes below and that will make if you watch that first this will make a lot more sense so we're gonna look at Pfizer it's a blue chip stock it's been around forever and when I'm writing covered calls on the stock I like to find stocks that pay a decent dividend yield in case the stock Falls a lot after I write the covered calls I want to be able to at least collect a dividend going forward so Pfizer kick is a good candidate for this currently has a 4% dividend yield and I believe the dividend yield is fairly safe in this environment you want to look for dividend yields anywhere between two and maybe four and a half percent you definitely don't want to go for the really high yield high yield stocks they can be a little bit more more dangerous in this environment so Pfizer is a good a good candidate currently currently trading at thirty seven sixty nine and so if you just click right here where it says options I would take us to the options price and page on Yahoo Finance now when I am writing covered calls I usually like to go about 45 to 60 days out I find that that is the sweet spot so if you see here if this is the drop-down menu here for the different expirations and again if you don't know an option expiration is be sure to watch that previous video which i've linked below so we're going to go about a little less than 60 days out we'll do the July 17th usually the third week of the month has the most open interest in the most volume it's the most liquid contract so we can see here these are all the calls as we said the stock is currently 37 69 3770 and Yahoo does a good job of showing you which calls are out at the money and out of the money so all these calls in this blue shaded area are are are currently in the money and so when we write cover calls in the stock we want to do them right at the money right where the stock is currently trading or slightly out of the money so the strike price that's the the first strike price that's just above the current stock price so current stock price 3767 we would be selling the 38 calls so if we click right here this will give us the pricing we can see if they're currently bid at a dollar 17 offered at a dollar 22 these are the 38 calls on Pfizer expiring July 17th 2020 now so I've already done a little a little work on this we're going to use slightly different numbers because they changed since I did it but basically this is how you do covered calls you buy the stock right where it's trading right now so you use a limit order or you can even use a market order if it's a very liquid stock like Pfizer so we're gonna buy a hundred shares roughly where it's trading right now it's traded up a little bit since I made this diagram be basically buy the shares where they're trading so 500 shares of Pfizer at 37 62 that will cost us three thousand seven hundred and sixty two dollars if you're using a broker like Robin Hood you don't pay any Commission's and that's why I'm not using any Commission's in this example if you use a broker that still charges commissions to trade stock or options they will obviously be some expenses that will that will slightly lower your profits here but either way it shouldn't make too much of a difference so we buy a hundred shares of the stock right where it's trading and then we sell the next call up the next strike price up that's about 45 to 60 days out as we said we're gonna be looking at the July so for every 100 shares that you buy you sell one call one call is equivalent of a hundred share so you have to do these in equal amounts if want to do a traditional cupboard call so we paid three thousand seven hundred sixty two dollars for one hundred shares of the stock we immediately sell and this is a cell to open you'll probably see me you can have different choices CELTA open gets you into a position it's a little weird when you first get started with this because you're selling something you don't own but this is basically just how it works you're selling to enter into a position and the nice thing about selling is you get to collect some money called the premium so we'll be selling one call at a buck fifteen the multiplier for options is always a hundred so if you see a buck fifteen and you're selling one call option you just multiply that by a hundred that tells you how much money you'll be collecting from this trade so we'll be collecting a hundred and fifteen dollars we buy the stock we sell a call against it now if we look at these sort of the return on investment of this trade or this investment it's it's it's looking quite good actually because so we'll basically take the premium when we collect which is $115 and we divide it by the capital that we deploy three thousand seven hundred sixty two so you divide these two and you get about three three percent which is for a holding period of two months is quite good as we saw you can hold your money in a savings account and you only make about one point three percent per year here we're already making three percent for two months now if you can do this every two months for a year do it six times a year you can make 18 percent in practice you won't be able to make quite this much because the stock will bounce around but if you get really lucky and you can do it the stocks or stays where it is and volatility stays where it is you can make about eighteen percent on this on this trade doing it every every two months for a year so what happens what are the different what's the sort of scenario analysis look like for this trade well if Pfizer if the stock is below thirty eight when this option expires in July of 2020 we get to keep the stock we still own 100 shares of Pfizer we get to keep the premium that we collected the $115 the call option that were short that we've sold to open expires worthless and we're basically done with the trade we've made three percent assuming the stock hasn't fallen a lot maybe we can just get out at the same price we paid or roughly the same price and so we've made three percent over two months now at this point what you can do is you can just hold the stock as we saw before it trades for about a four percent dividend yield so if you hold the stock for another year and they keep their dividend which they should you'll make another four percent on top of this three percent so you'll be making about seven percent in twelve months you can also if we're still below the thirty eight strike price you can sell another thirty-eight call call it forty-five to sixty days out so when this expires in July maybe you would go forward in salvo to sell the September the September even the October you can sometimes go 90 days out if you want and you can collect a little bit more premium in exchange for a little bit more risk because you'll be holding the stock for longer so that's what happens if Pfizer is below the strike price of the call at expiration you keep the stock you keep the cash that you made you keep the premium you collected the call option expires worthless it disappears from your account and you're just a stockholder in Pfizer you can sell another call or you can just sit there and collect the dividend now let's say Pfizer has rallied a little bit by July by expiration if Pfizer is trading above 38 when this option expires you still get to keep the dollar at $115 but the stock will be called away from you this is why they're called call options the stock will be taken away from you it'll be sold at $38 and so you will get to make the difference between the price you paid 37 62 and the price that was sold for 38 so that is a 0.38 0.38 on the stock you own a hundred shares so that's an extra thirty-eight dollars that you pocket from this trade and so when you combine that with the the $115 that you made by selling the call you've collected one hundred fifty three dollars over this this holding period which is better than four percent in two months so again if you can do this if you could do the same thing six times a year do whatever you do it every two months you'd be making about two 4% in your money which would be obviously obviously amazing in practice we'll be less than that but these things are possible now what happens if the stock falls a lot so let's say we buy it at 37 62 and instead of instead of rising or staying the same let's say it falls down to 35 well in that case we still get to keep the $115 so we collected the stock is below 38 so it won't be taken away from us and won't be called away from us we'll get to keep the $115 premium and now what we can do is we because we picked a good stock we're confident in Pfizer again I'm just using this as an example but if you think they have they're going to continue to do well or at least stay as good as they are now you can just hold the stock and you'll still be making a 4% dividend yield and so you'll still be really beating money in a savings account I'll be it ticking a little bit more risk so you can just hold on collect those quarterly dividend payments those dividend payments that come every three months and then you can sell it when it gets back up to 37 62 price you paid for the stock or if you want as it gets close there maybe when it gets back to 37 or 37 20 somewhere around there you can sell another 38 call 45 60 90 days out and collect more premium and so this is a way it's very very satisfying sort of trade you get to keep milk in the stock and pulling out these premiums and you can see that if you continue to do this it will essentially lower your cost basis so that's another way of thinking about it that every time you sell a call for call it a dollar it lowers your cost basis by a dollar so if you do this 30 sometimes 35 times 36 times you will basically have a cost-free position in Pfizer because you will have monetized it you will have collected all this premium over time so those are the three scenarios the stocks above 38 in which case the stock gets called away from you if it's below 38 you keep the stock you can collect the dividend and maybe sell another call the one scenario where you do badly is if Pfizer starts to do really badly see the stock could go to zero or it could go down a lot in which case at least you're still collecting the dividend worst case scenario they cut the dividend and you're stuck with a loss now why is this not as bad as just holding the stock well if we just bought Pfizer and it did badly we wouldn't stand to lose 37 dollars you know the full amount three thousand seven hundred and sixty two dollars but because we sold a call up front we're sort of cushioning our downside and the more calls that you can sell over time the more you cushion this downside so in this sense covered calls are actually safer than holding the underlying stock and not doing covered calls on it because if you hold just the outright stock and it falls you can lose this amount but if you've collected 115 dollars first you can only lose three thousand seven hundred sixty two dollars - 115 dollars so that's something to keep in mind this is one example of an option strategy where it's actually safer than holding the underlying stock now you are giving away the upside so if you think Pfizer's go into 50 you definitely don't wanna sell a 38 call and have a called away from you at 38 and then you watch it go to 50 so you want to pick do this on stocks that you don't expect to go up a huge amount but maybe expect them to trade in a range sort of chop around in a range now if you're doing this trade on Robin Hood I can show you how to do it basically you type in type in the ticker PF e up here you enter a limit price the car stocks currently at 37 67 so I'll just use a limit price maybe slightly above that 3770 I'm gonna buy a hundred shares I click review the order and I buy the stock now immediately after buying it I want to sell a call so what I will do is you have to click down here where it says trade PFE options after I after I buy under chairs to the stock that will take me to this options page and they have a really nice interface I like this it's quite intuitive so I'm gonna be selling a call because I'm doing covered calls I'm gonna pick the July 17th expiration as we said and I like how they do this the you can see the share price is right here 30 769 and so you'll always want to sell the call that's right there if there was a 3769 call I would do it or you just go up a strike price so as we said we'll sell the 38 call right here the numbers have moved around a little bit since I did my example but basically what we'll do is we'll just click the plus button here it says short call and we can use basically just continue and in this case well instead of collecting a buck 15 will collect a buck $24 and 24 cents by selling this call because the stock has rallied a little bit and so the calls are have increased a little bit in volume and value but that's the two-step process you buy a hundred shares of the stock you sell a call at a strike price that's right above the price you paid for the stock so Pfizer is a great one to do the song there to others I wanted to give you one is a slightly higher price stock depending how much capital you have because when you do cover calls you always have to buy at least a hundred a hundred shares a hundred shares per one call option so in this case it would cost call it 18,000 $19,000 mcDonald's good long-term prospects and they paid their dividends not quite as high quite as high as Pfizer it's probably more of a growth stock than Pfizer and but they still pay a good two point seven one percent dividend yield which beats beats any savings account and so we would do something similar we would buy the stock at $189 26 cents and then we would go maybe the same go back out to the same expiration and we would sell the next call up which is the one ninety calls we can see here that we would be collecting 590 so let's see what that is 590 divided by the price we pay for the stock one eighty nine point two four so it's about three point one percent it's fairly fairly similar so that's something you could do on McDonald's you can do it on Pfizer Starbucks is another fairly conservative one that Starbucks isn't going anywhere soon they currently pay ticker is SBU X they currently pay a dividend yield of just over 2% so not as good as McDonald's or Pfizer but still a decent dividend yield and then we do something very similar so we buy the stock at 78 98 we click here and look at the options and we go 30 60 days out go to the July 17th and we will be selling that the next strike price up which are the 80s so we can currently sell them for about 320 and collect for one call option collect 320 dollars that's how call options work if you want to go a little bit more in-depth I have a whole course that covers how to make money with with with covered calls and there's 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Channel: Trader University

Views: 40,616

Rating: 4.9108825 out of 5

Keywords: covered calls for income, selling covered calls for income, writing covered calls for income, covered calls for beginners, covered calls, covered calls explained, covered calls on dividend stocks, covered calls options trading, covered calls strategy

Id: KDdLn2ku_xc

Length: 18min 47sec (1127 seconds)

Published: Tue May 26 2020