Generating Income with Options
A Covered Call Options Strategy
If you ‘own’ assets in the stock market you can, in effect, rent those assets out to other investors and earn extra income. How in practice does this work and what kind of returns can you expect over time?
Take the case of an investor who owns a diversified portfolio of, for example, ten FTSE 100 companies. By selling ‘call options’ on those shares through your stockbroker in the normal way, the investor can generate income. In effect, the investor is selling other investors the right to buy his/her shares off them at a pre-agreed price over an agreed timeline.
Of course, there is no free lunch in the stock market. If the investor’s shares subsequently rise in value then he/she will lose those shares (to the investor who bought the option) and forego some of the capital gains. But he/she should get some of the uplift in price and will keep the income from the options he/she sold.
The developed stock markets have generated annual returns of 9-10% over the long term (but clearly not in the 2000s to date). Using options in the above described way can deliver those returns in a more smoothed manner. When markets rise by say 30%, a 'Covered Call Options' approach might deliver a 15% return in that same year. But, equally, if markets decline by say 20% in a given year, the 'Covered Call Option' approach will cushion that decline with additional income of perhaps 10% in that difficult year.
Selling ‘call options’ in this way is not risky as the investor owns the underlying shares and if the shares are ‘called’ from him/her, then they can deliver those shares. For this reason, it is called ‘A Covered Call Options Approach’ as the risk of selling options is covered.
The fact is that over 90% of out-of-the-money call options expire worthless. These are options where the exercise or strike price is above the current price i.e. the fixed price at which you agree to sell your shares is above the current share price at the time of selling the call option. Consistently selling ‘call options’ on shares you own, in good market conditions and bad, is a reliable method of generating an above average income (and most probably an above average return also) in the stock market.
Our research has shown that an investor could generate an income of 8-10% annually (excluding capital gains) by consistently selling ‘call options’ in FTSE 100 stocks in this way. If you apply this approach using one of The InvestR Centre’s FTSE 100 value-based approaches, our research has also shown that the approach is capable of annual returns of 12-15%, at least, over time. Certainly, this was the case over the 1995-2009 period.
The InvestR centre's Services in This Area For Members
Members of The InvestR Centre can follow the approach live on our web site. We pick the stocks, we sell the ‘call options’ and we report the performance weekly and annually. We also feature the approach regularly in the ‘Weekly Investment Bulletin’ that is available to members.