Did you know that you can get passive income from stocks that don’t pay dividends?
You might be surprised to learn that, but it’s true!
Through a certain type of derivative, you can turn any stock — dividend or no — into a passive-income opportunity. Although this method isn’t quite as “passive” as collecting dividends, it takes less effort than most so-called passive business models. And, not only does it pay you, but it also reduces the risk in your investments. In this article, I will explore this passive-income derivative and how it can reward you over the long term.
Covered calls
A covered call is a type of option that pays you to sell your stock to someone else at an agreed-on price. In exchange for agreeing to sell the person the stock at that price, they pay you a fee called a premium. If the stock hits the agreed-on price, you have to sell your shares — but you still get to keep the premium. If the stock doesn’t hit the agreed-on price, you keep both the stock and the fee. So, you’re always generating income from covered calls, whether the stock goes up or down.
How this works
To illustrate how covered calls work, let’s imagine that you held 100 shares of Shopify (TSX:SHOP)(NYSE:SHOP) that you bought for $1,500. Shopify pays no dividend, so normally, you would not be able to get passive income out of it. The only way you could generate income from it would be to sell the stock.
If you like Shopify’s long-term prospects, you may not like that idea. So, as an alternative, you could consider writing covered calls on your SHOP stock. If your brokerage account is approved for options trading, you can easily do this. All you have to do is go under options and choose the option to “sell” or “write” covered calls (your broker may use either term).
Once you’re in your broker’s options trading interface, you can write/sell covered calls on your SHOP stock. You need to select a strike price (the price at which you agree to sell the stock) and the expiration date (the point after which the buyer either exercises or finds their options worthless). If your SHOP stock hits the strike price it gets called away and you keep the premium. If it doesn’t, then you keep the premium and the stock.
So, if you got a $2 premium for 100 SHOP shares with a $2,000 strike price, and the stock stayed at $1,500, you’d get $200 in pure profit.
If, however, the stock fell to $2,001, you’d collect that $200 all the same (but miss out on a potential capital gain).
Writing covered calls comes with the potential to sell your stock at a price that isn’t favourable to you. But the upside is guaranteed income. It’s your call — pun very much intended.
