Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Use Covered Calls for Extra Income
Transcript
- Lucas: Let's say you have a hundred thousand dollars of Apple stock in your post-tax brokerage account, and you're five years into early retirement. The dividend yield on Apple is about half a percent, so you're getting roughly five hundred bucks a year from dividends on that position. Not bad, but not exactly covering your living expenses. Luna: Right. And you don't want to sell the shares because you like the growth story and you'd trigger a capital gains tax bill. Lucas: Exactly. So one way to squeeze more cash out of that position without selling it is to sell covered calls. You own a hundred shares of Apple, you sell one call option contract — each contract covers a hundred shares — giving someone else the right to buy your shares at a specific price, called the strike price, on or before a specific date. Luna: And in exchange for that obligation, you collect a premium upfront. That's the income. Lucas: Right. Let's put actual numbers on it. As of mid-July 2026, Apple is trading around $190. You could sell a call option with a strike price of $200, expiring in about a month. That option would trade for roughly three dollars per share, so three hundred dollars total premium for one contract. Luna: Three hundred dollars on a hundred thousand dollar position — that's 0.3 percent in one month. Annualized, that's about 3.6 percent, on top of the dividend. Lucas: Exactly. And that's a meaningful boost. If you're following a 4 percent withdrawal rule, that covered call income alone covers almost a full year of spending on that position. But there are trade-offs. Luna: The big one is that you cap your upside. If Apple rallies above $200 by expiration, your shares get called away and you sell them at $200, missing out on any further gains. Lucas: Right. So you need to be comfortable with that outcome. In early retirement, where you're relying on the portfolio for decades, you don't want to systematically sell your winners. But if you're selling calls on a position you'd be happy to sell at a certain price anyway, it can work. Luna: So you'd pick a strike price that's above the current price but at a level where you'd genuinely be okay selling. Like $200 for Apple when it's at $190 — that's about 5 percent upside. Lucas: Exactly. If Apple hits $200 in a month, you make the 5 percent price appreciation plus the 0.3 percent premium. That's a great outcome. If it stays below $200, you keep the premium and you can sell another call next month. So you're basically monetizing the fact that the stock probably won't shoot up 10 percent in a single month. Luna: But what about the tax treatment? The premium is short-term capital gain if the option is held less than a year, so it's taxed at ordinary income rates. That could be a drawback for retirees trying to manage tax brackets. Lucas: That's a great point. The premium is indeed short-term. But if you're in early retirement and your only other income is from dividends and maybe some Roth conversions, you might have room in the lower brackets. And if the option is held for more than a year — which is rare — it would be long-term gain. But practically, most covered calls are short-dated, so you're looking at ordinary income rates. Luna: There's also the risk of assignment early if the stock goes ex-dividend. If Apple pays a dividend while your call is in the money, the option holder might exercise early to capture the dividend, and you'd have to deliver the shares. Lucas: Yes. That's a real risk. But in practice, for out-of-the-money calls, early assignment before expiration is rare. It's more of a concern if the call is deep in the money. So as long as you sell strikes above the current price, you're usually fine. Luna: So who is this strategy actually for? I can see it working for someone who has a concentrated stock position that they don't want to sell for tax reasons, but they want to generate some cash flow. Lucas: Exactly. It's not something you'd do with your entire portfolio. But if you have a big winner from your accumulation years — say you worked at Apple and accumulated a lot of stock, or you bought NVIDIA years ago — selling covered calls can be a way to generate income without triggering a huge tax bill. You're essentially turning a non-dividend-paying stock into an income-producing asset. Luna: And if the stock gets called away, you sell it at a price you agreed to, and you've already collected the premium. So you don't feel like you missed out. Lucas: Right. And you can always buy back the stock later if you want, though that resets the cost basis for tax purposes. But there's a psychological discipline required. You have to be okay with the stock being called away. If you're emotionally attached to the stock, this strategy will drive you crazy. Luna: That's a good point. Now, one thing I've seen people do is sell weekly calls instead of monthly to capture more premium, but the time decay is faster and the premium per week is lower. Is that worth it? Lucas: It can be, but it's more active management. Selling monthly calls gives you a nice rhythm — you do it once a month, collect the premium, and move on. Weekly calls require more attention and more trading commissions. For most early retirees, I think monthly is the sweet spot. You don't want your retirement to feel like a second job. Luna: Yeah, and the whole point of financial independence is to have freedom, not to be glued to a screen watching options expiration. Lucas: Exactly. So let's talk about the practical steps. You need a brokerage account that allows options trading — most major brokers do. You'll need to apply for options approval, typically at Level 1 or 2, which covers covered calls. Then you simply select the stock you own, choose the expiration date, pick a strike price above the current price, and sell to open. Luna: And how do you decide what strike price to pick? Is there a rule of thumb? Lucas: I like to sell at a strike that's about 5 to 10 percent above the current price, with about 30 to 45 days to expiration. That gives you a decent premium while still leaving room for the stock to appreciate. If you sell too close to the current price, the premium is higher but you risk getting called away too easily. If you sell too far out, the premium is tiny and it's not worth it. Luna: What about in a volatile market? If the stock is swinging a lot, the premiums will be higher, but the chance of hitting the strike also increases. Lucas: Right. High volatility is actually good for option sellers because you collect more premium. But you also have to be prepared for bigger swings. In a high-volatility environment, you might want to sell calls at a higher strike to give yourself more buffer. The key is to be consistent and not chase premiums. Luna: One thing that's often overlooked is the impact on your overall portfolio allocation. If you're selling calls on a stock that represents a big chunk of your net worth, and it gets called away, you suddenly have a lot of cash that needs to be reinvested. That can create a tax event and a rebalancing challenge. Lucas: Absolutely. So it's best to do this on a position that's a manageable size — maybe 5 to 10 percent of your portfolio. That way, if it gets called away, it's not a portfolio-shaking event. And you can use the cash to buy something else or just hold it as part of your fixed-income allocation. Luna: Speaking of which, Lucas, our show has always been ad-free because we believe the information should speak for itself. If you find value in these conversations and want to support that approach, you can find us at buy me a coffee dot com slash fexingo. It's a simple way to keep this going without any sponsors. Lucas: Absolutely. And we appreciate those who do. Now, back to covered calls — another common mistake is selling calls on stocks you're not willing to sell. If you'd be devastated to lose your shares at the strike price, don't sell the call. It's that simple. Luna: Right. So you need to be clear about your intention. Are you using this as a source of income, or are you using it as a way to exit a position at a target price? Both are valid, but they require different strike prices. Lucas: Exactly. If you're using it as an exit strategy, you might sell a call at a strike that represents your target sell price. If you're using it for income, you sell further out of the money and plan to roll the option forward if it gets close to being in the money. Luna: Rolling — that's when you buy back the option you sold and sell a new one with a later expiration or a different strike. That can help you avoid assignment if the stock moves against you. Lucas: Yes. But rolling is an art. You don't want to do it too often because it incurs trading costs and can lock in losses. Generally, if the stock is approaching your strike, you have a few choices: let it get called away, roll up and out to a higher strike and later date, or buy back the option at a loss and stop selling calls. I usually advise letting it get called away if you're okay with the price, because that's the cleanest outcome. Luna: What about using covered calls in a tax-advantaged account like an IRA? The tax treatment is different — you don't have to worry about short-term vs. long-term gains, but you also can't deduct losses in the same way. Lucas: Right. In an IRA, all option income is tax-deferred or tax-free if it's a Roth. That can be a great place to use covered calls because you avoid the tax complexity. The downside is that you can't use any losses to offset other gains, but since covered calls are typically profitable if done consistently, that's less of a concern. Luna: And you don't have to worry about the wash sale rule in an IRA, which can be a headache for tax-loss harvesting. Lucas: Exactly. So for many early retirees, using covered calls in a Roth IRA is a no-brainer. You get tax-free income, no capital gains concerns, and you can reinvest the premiums without tax consequences. Luna: But let's be realistic — how much income can you really generate? If you have a $500,000 portfolio and you sell calls on a $50,000 position, you might generate $150 to $200 a month. That's not life-changing, but it's a nice supplement. Lucas: Right. It's not going to replace a salary. But if you're already living off a 4 percent withdrawal rate, an extra 0.5 to 1 percent from covered calls can give you more breathing room or allow you to spend on something you otherwise wouldn't. And it's a way to stay engaged with your portfolio without making drastic changes. Luna: So the bottom line: covered calls are a tactical tool, not a core strategy. They work best for specific positions in a diversified portfolio, and they require discipline and a clear plan. Lucas: Well said. And as always, it's important to understand the risks before you start. But for those who are comfortable with the mechanics, it's a legitimate way to generate extra income in early retirement.