Everyone enjoys receiving dividends. Much like receiving interest, dividends are pure passive income. The best kind of income. You get paid no matter what you’re doing — reading a book, listening to the radio, on an airplane; it doesn’t matter, you still receive the dividend. There is another kind of security that behaves almost the same way — covered calls.

In order to understand covered calls, we first need to understand calls. A „call option“ is an investment product that awards the purchaser the right to purchase stock for a known price (called the strike price) on or before a certain date (called the expiration date). In exchange for this right the buyer pays ‚premium‘ (money) to the seller. If the buyer decides he wants to exercise the right granted to him by the option, then the seller must sell the shares at the strike price (the seller also gets to keep the option premium he received at the beginning of the trade).

Imagine Tom likes ABC Corp. He wants to buy 100 shares of ABC Corp for $30 between today (March) and 3 months from now, but he doesn’t have enough money to buy 100 shares. So instead, Tom buys 1 call option on ABC Corp stock with a strike price of 30 that expires in June. Let’s say ABC Corp is trading for $27 today… so Tom might pay $100 (for example) for the right to buy ABC Corp at $30 between now and June. He does this because he believes ABC Corp will move above $30 between today and June. If ABC Corp rises to $40 then Tom can exercise his option right and force the seller of the call option to sell him 100 shares of ABC Corp at the agreed upon strike price ($30/share). Tom will have to pay $3000 for these 100 shares, but he can then sell the shares the same day for $4000, pocketing $1000 (minus the $100 in premium he paid to the seller when he bought the call in March). On the other hand, if ABC Corp finishes below $30 in March then Tom’s option expires and he loses the $100 in premium he paid.

Generating monthly income by selling covered calls to other people is not difficult. If you do it with stocks you already own then the call options you are selling are ‚covered‘ (because if the options you sold are exercised against you, you already own the shares you will need for delivery). If it happens that your stock is called away then you receive the strike price per share for your stock. If you still want to own the stock then you can either buy back the option before it expires, or wait until it is exercised and then use the proceeds to go into the open market and buy more shares to replace the ones you lost during exercise.

Many people use covered calls to create recurring income. It is a passive investment strategy where you can collect a little option premium each month. If one of your stocks rises above the strike price then the option buyer may exercise the option and pay you for your stock. You still made money, but you may not have made as much as you could have if you hadn’t sold the option. On the other hand, the option premium that you’ve been collecting each month provides current income and some downside protection should your stock drop in value during the life of the option. Covered calls are the most popular of all option-based strategies and are easy to learn and sell.

Born To Sell’s site offers additional information about covered calls. Know what’s better than low bond interest? Time premium on options! Check out Born To Sell.