In this strategy that we are going to review is the concept of writing covered calls to generate income.

Writing covered calls involves selling call options against your existing shares. To implement the strategy, you must first own the shares of the ETF, and then sell 1 call for every 100 shares you own. By taking that action, you are paid in cash up front for giving someone else the right to buy your ETF at a specified price during a specified time.

When you combine this strategy of writing covered calls with ETFs, you create an effective way to generate steady cash flow from the stocks you own, a way to reduce the cost basis of your investments, and a way to ensure that your money always working for you.

Let’s apply this strategy to the iShares CDN Large Cap 60 (XIU) index fund

In this example, the XIU is trading at $12.50 per share. Through your analysis, you are anticipating that the market will be range bound for the next 4 months. With a bullish range of $13.50, our goal is to generate some income while we wait for the markets to turn.

When we look at the 4-month $13.50 covered call, it offers $0.55 cents per share. If we bought 1000 XIU shares at $12.50 it would cost us $12,500.00. We then sell 10 calls against XIU stock and generate a cash flow income of $550.00.

That $550.00 represents an initial guaranteed cash flow of 4.40%. Real money you made today!

They paid us that cash, because we are giving someone the right to buy our XIU shares at $13.50 over the next 4 months.

Let’s look at the different outcomes: We originally bought 1,000 shares at $12.50 for a total of $12,500. We then sold all 10 calls and generated $0.55 cents per share or $550.00 cash flow creating a new reduced average cost of $11.95 or for a net debit of $11,950.

If the XIU has risen above the $13.50 level at the end of the 4 months, your shares will be allocated and you will sell your shares at that strike price of $13.50 or $13,500

That’s a profit of $1550 on your adjusted cost basis, which is close to a 13% return in just 4 months!

Alternatively, if the XIU price is below the $13.50 price at the end of the 4 months, you will still own the XIU shares while retaining the 4.40% cash flow. While creating a new adjusted cost base, you can now write new covered calls.

The second strategy that we are going to review is the principle of selling put options to generate income in ETFs.

Writing put options is an excellent way to build cash flow into your portfolio and a solid way to reduce the average cost of existing ETF positions. Also, this is a great alternative way to shop at a marketplace.

What does it mean to sell a put?

When you sell a put option, you are paid in cash up front for giving someone else the right to sell you the shares at a specified price during a specified period of time. You would sell 1 put for every 100 shares you are willing to own.

Let’s apply this strategy again to the iShares CDN Large Cap 60 Index Fund (XIU). Again, in this example, the XIU is trading at $12.50 per share. Through your analysis, you are anticipating that the Canadian market will be range limited for the next 4 months. Range down to $12.00 or about 4% lower than the current market.

Our goal is to generate some income while we wait for the markets to turn. When we look at the 4-month $12.00 strike put, it offers $0.87 per share. If we write 10 put options, it would generate a cash flow of $870.00 by being forced to buy 1000 shares at that price of $12.00.

That represents a cash flow return of 7.25% for being obligated to buy XIU shares at $12.00 over the next 4 months. If assigned in the XIU, you will now own all 1,000 shares at an average cost of $11.13 per share. That represents the purchase price of $12.00 minus the cash flow of $0.87.

This is a reasonable way to average down your existing positions or use it as an entry strategy to accumulate new ones.

Alternatively, if the XIU trades above the $12.00 price at expiration, the put option will expire. You will keep the winnings and have no further obligations.

To summarize, writing covered calls and writing puts are excellent, conservative strategies for generating steady cash flow in a portfolio. Best of all covered calls are eligible on registered accounts. While the bill of sale is limited to standard margin accounts.