Our new source of passive income!

Greetings all!

Today we’re going to be exploring our newest source of (mostly) passive income.

I will call this new income stream of ours mostly passive because it does require a small amount of work up front to bring in and a recurring small amount of work periodically every couple of months but all in all its no real additional work compared to work I’d already be doing maintaining our investment accounts.

So what is this new income stream I’m referring to?

We’re going to be trying out covered calls to produce some additional income. And in specific selling covered calls.

What is a covered call?

Since there is a lot of reading and learning to be done to truly understand options trading (which I am knowledgeable in but nowhere near an expert) I’ll stick to explaining just the covered call in the way I plan to use it – which is to sell a covered call for side income on my dividend stocks.

Selling a covered call is basically me just saying to the buyer “hey I’ve got 100 shares of XYZ company, they are currently worth $16.00/share I’ll sell them to you for $17.00/share in x amount of time regardless of how high the price goes if you pay me a small premium up front”

How I’ll use covered calls:

The first step is for me to own 100 shares of a given dividend paying stock, you need to own 100 shares because in order to write one single contract for a covered call it is an agreement on 100 shares to change hands.

The next step is to look for the options chain on said stock:

This is the option chain for Suncor Energy for December 18th and as you will see in my later picture these numbers change frequently and you can also look various distances into the future which will change the premium you receive.

For now we will focus in on a $17.00 strike price as the current price of a suncor share is $15.83.

Next I go out and buy 100 shares of suncor so 100 shares x 15.83 = cost of $1583

I then sell a contract of a covered call with a strike of $17.00 so in the above that means I receive the 0.72 bid column x 100 shares = $72 up front today.

Next we wait.

Come December 18th 2020 if the shares remain below the $17 strike price I keep my 100 shares of Suncor in my portfolio and keep collecting my dividends as I would normally do.

The bonus is that I would then also keep the $72 payment I received at the time the contract.

What this has effectively done is allowed me to receive $0.72/share for doing nothing thus acting as an additional $0.72 dividend of sorts or reducing my cost basis to $15.11 per share ($15.83 -$0.72) hope that is clear to understand.

In the event we keep the shares we’ve now received a 4.5% return independent of where the share price has gone on these shares ($72/ $1583 = 4.5%)

Even if the shares had gone down 10% in this time that doesn’t really affect this calculation as these are shares you would be holding in your portfolio regardless.

The other outcome is for the share price to go up above $17.00/share.

In this instance I would have to sell my 100 shares at $17.00 even if the price is truly now $20.00/share which could suck, however I knew this going into the contract. This “worst case” has now allowed me to make $1.17/share or $117 in gains on the sale from when I bought while again keeping the $72 premium I received up front for a total gain of $189.

If you’ll remember back to the start these shares cost us $1583 so a gain of $189 is nearly 12% gains in a month and a half of holding a stock… not too shabby.

Of course we need to remember to deduct transaction fees which vary based on broker so we’ll say $10 flat fee would eat into our profits by $10 but still a great gain.

The plan would be to not lose the shares and instead be able to continue writing covered calls as the opportunity arises and thus keep making a few % a few times per year on several holdings.

How to decide which company to use?

Great question… I need to emphasize that the first criteria is these have to be companies you don’t mind holding in your account for the long haul as you could be stuck with them if the price doesn’t meet the strike.

In my case I’m hoping to keep all of my shares so this is the preferred outcome and I’ll even set the strike price a little higher and reduce my claimed income in order to try and keep as many shares as I can.

I narrowed it down to a few companies for my first calls and ran a quick analysis using a spreadsheet that took me about a minute to make:

All I did was took 4 stocks that I like holding in my dividend portfolio, in this case Manulife Financial, Telus, Suncor and Hydro One.

Next took the cost of buying the 100 shares, settled on a strike price for each and then found the premium I would receive based on which week the covered calls expired – in the above those dates are Nov. 13, Nov. 20, Dec. 18th 2020.

The $gain is the price I would gain purely from buying and selling the shares at the strike price, the total gain is factoring in the sale profits and the premium received assuming a December 18th contract date.

The Gain % is my total gains assuming that the strike price is reached and I sell my 100 shares, to see how much I’d make if the strike doesn’t get reached its simply the number found in each column under a given date so for Suncor I would make $86 the day I wrote the contract.

Wrap Up

So there you have it, our newest source of (mostly) passive income.

I hope that I was able to lay out my thoughts clearly for you today to help paint a visual I am writing this with a baby hanging off the front of me in his carrier because he has decided he doesn’t want to be put down today after receiving his shots.

As always our blog is for entertainment and sharing our investing and F.I.R.E. journey so please do not take this as financial advice and always do your own due diligence and consult with an investment professional prior to making any moves in your financial life.

If you’ve got questions or comments leave them below or over on our
Instagram @FindependenceCanada and we’ll be sure to respond.

Thanks for stopping by,

FIC.