Paying rent by selling covered calls?

My good friend Jason from the covered call has been telling me about his income-generating strategy of selling covered calls for a while, and I never bothered because I was building a business and making income.

For the longest time, my idea was to hold on to my Bitcoins, Gold, etc. and focus on the capital gains.

Now, I'm in a different position. I'm starting something new, and without income, sooner or later, I'll have to start selling off assets. Until now, I've had enough cash and stuff in my portfolio that I wanted to sell anyway, but slowly, I'm getting to the assets that I have a hard time selling.

I could get a job, but I enjoy this game of exploring how all this new tech will work, trying out different business ideas and spending time writing a bit more.

That's where Jason's strategy of making money with money came back to mind. I'm still bullish on BTC and Gold and don't want to sell these for dividend-generating stocks or ETFs.

I've spent the last couple of days diving a bit deeper into this and want to try and wrap my head around it here in a simple non-financial expert tone.

How does a covered call work?

A call option is buying a ticket.

A ticket that you CAN use to buy shares at a set price.

The ticket expires at a set date.

Say a ticket to buy TSLA at $450 next Friday is $5. TSLA is currently at $430.

If before the expiry date the price of the shares goes beyond the price on the ticket you CAN buy the shares cheaper with your ticket. So if TSLA moved to $460, you could buy the shares from the ticket seller for $450.

If the share price does not move beyond the set price, then the ticket expires worthless, and you've wasted $5 on the ticket.

Pretty cool strategy if you're bullish on something and the ticket isn't too expensive.

A covered call now means selling the ticket instead of buying it.

This is risky, as you would have to cover the cost of selling the shares at a much lower price to fulfil the ticket obligations. The buyer of the ticket CAN buy the shares at a set price, so if that price doubled, you, as the seller, would have to deliver the expensive shares.

If TSLA were to go to $900, you'd owe the difference to the price set in the ticket. The downside for you, in theory, is unlimited, as share prices can go up a lot.

To mitigate risk, you can hold the shares you are selling tickets for. So you collect money for the ticket, and in case the buyer wants the shares, you can sell your shares (they would have gone up too).

In this case, you can hand over the $900 TSLA shares and don't incur any real loss while pocketing the $5 ticket price.

That's the main risk.

If the shares you are selling covered calls for run up in price too much, you miss out on gains.

Opportunity cost.

In the scenario above, you made $5, but by simply holding TSLA, you could have made $450.

Ideally, you'd want something that doesn't move up or down too much, but instead moves sideways.

Key Parameters

I'll start with an example.

Here, we suggest selling a covered call to buy TSLA at $485, expiring on October 12 (at the time of writing, this is 21 days out).

The ticket would be worth $962 (the premium).

Based on the current market volatility, the risk of assignment (TSLA moving to ~ $490 so the ticket buyer would want to buy the shares) is 19.9%.

Annualised, this strategy could yield 39.2% or 0.8% weekly.

Now, this is a rough estimate, but it paints the picture that if you hold 100 TSLA shares, you could make some additional money, and it might be a profitable strategy IF TSLA doesn't move too much.

100 TSLA shares would be worth $42,600, and if I continued to find these opportunities throughout the year, the 39% return could accumulate to approximately $16k, which is almost my annual rent.

What could go wrong?

Now the potential gains sound juicy, so what's the catch?

Opportunity cost.

Don't let the chart below overwhelm you. It illustrates how a covered call with specific parameters would compare to holding Bitcoin outright.

To be honest, it would have been a poor choice to sell covered calls on Bitcoin in this scenario.

You'd be making money, yes, but you'd be making way more money by just holding Bitcoin.

The red dots on the second chart above show the assignments of our calls, i.e., Bitcoin went above the strike price of that covered call. Every time that happens, our opportunity cost stacks up. The fee is nice, but it does not cover the rise of Bitcoin itself.

On top of that, if you have to sell your $460 TSLA calls, while the price went up to $480, you don't just miss out, but when you want to buy back in, you need more money to get back to the same position.

Getting back into the trade

Here is where picking the right asset for this gets important. If it goes up too quickly, then it's not going to work well, but if the asset is volatile and sideways, then it might work well.

Say you got assigned, had to sell your shares, and they went up another 20%. You could suck it up and buy back in with the loss to continue the strategy, but that would likely be even worse.

The alternative strategy is to sell a cash-secured put.

A put is pretty much a bet in the other direction. You buy a ticket to buy shares at a lower price.
Say TSLA is $450, and you sell a ticket to buy them at $440.

Similar to the covered call, you'll collect a fee for the ticket, and if you are assigned (i.e., the shares move beyond the defined price), you will have to buy the shares at $440.

If your covered calls ran away from you, this is a good bet to try and get back in at a cheaper price, while collecting the ticket fees.

The risk again is opportunity cost. If the shares move to $400, you'll have to buy them at $440.

Once you got assigned (i.e., you had to buy the shares), you'd switch back to covered calls.

As you may have figured by now, this is a strategy that works well with shares that move sideways or slowly upward.

You play the game to collect the fees and shouldn't mind holding these assets for some time.

Picking the best asset

My primary concern with the covered call strategy in general is that an asset might completely run away from me (down or up).

Say you started this with Bitcoin at $60k. It's now trading somewhere above $100k for at least the last 6 months, so you wouldn't have been able to get back into the trade for that whole time without paying a higher entry price.

That's a significant risk.

However, I am facing a choice right now: sell my shares to pay for living expenses, or hold them and generate income. There is some risk of not making as much as with holding, but the alternative is to sell assets straight out for cash.

For that, a covered call strategy seems to be a nice option if you prefer not to go down the degen path (Ethena offers 8% APY holding a coin that is backed by BTC/ETH).

While exploring all of this, I built a little calculator to help me understand the assignment risk, potential premiums, and quickly compare different strategies. You can try it out under Days to Expiry to get you started.

Here's where personal preferences, risk appetite, etc., come into play. I'm going to play around with this over the next months and report back on how it's working. My goal is to apply this strategy with as little effort as possible and be able to at least pay rent with the yields.

How will it compare against holding Bitcoin? I don't know. It really depends on the risk I'm willing to play here and whether Bitcoin moves sideways or not.

If I take on a moderate risk, the return isn't as great as TSLA (1.5% weekly). I'd be buying the IBIT as iShares has a decent reputation, the fees are low, and you can buy options.

More risk, of course, brings more reward here, but still not as good as TSLA and others.

So maybe it's better to sell some Bitcoin and buy some random company that fits the profile to somehow stay invested, but farm these premiums.

One could try and read the tealeaves here, but who the knows. In a good year, the return from covered calls won't beat Bitcoin.

In a bad year, it might, but that's not the point.

My alternatives are

1. selling some Bitcoin to pay rent

2. accepting the risk of opportunity cost by selling covered calls on the IBIT with lower returns

3. selling Bitcoin for a higher-yielding covered call asset, but that also means opportunity cost, but potentially higher yields

Haven't decided on Bitcoin yet, but have sold some calls on other holdings. Will keep you posted how it goes.

(the screenshots above are from a little tool I build to find the best covered calls - you can find it on Days to Expiry )