Unit 2 · Level 2 · Covered calls & cash-secured puts
The 'free income' myth
'Earn 2% a month on stocks you already own!' Every yield has a source. That's Formiga's oldest rule. Option premium is no exception: covered-call income is the sale price of your stock's upside; put premium is an insurance fee for downside you agreed to absorb. The buyer on the other side isn't a charity. If someone pitches option income as free money, they're describing the coin flips where it worked and skipping the ones where it didn't.
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What you get asked
Where does covered-call 'income' actually come from?
The premium is a price, not a gift. Some months the upside you sold was worth nothing; occasionally it was worth ten times the premium. It nets out to a trade, not a salary.
And put-selling premium: what is it payment for?
Put buyers are often hedgers paying for protection. Insurers profit in calm years and pay out in disasters. Sell puts long enough and you will meet a disaster.
Option premium is payment for taking on ___, not free money.
Sold upside or absorbed downside: either way, the cash you collect is compensation for a risk that occasionally shows up and collects back.
Match the pitch to the honest translation
There IS a legitimate case for premium selling: implied volatility has historically tended to run above realized. But that's a modest, sometimes-negative edge, not a yield.
A fund advertises '12% annual income from covered calls' next to a savings account paying 3%. What's the sharp question?
Higher 'yield' than the risk-free rate always means risk is being sold somewhere. Covered-call funds did famously less than the index in 2023-24's rallies. The yield wasn't free, it was traded. 🐜
The rest of this unit
Renting out shares and getting paid to bid: income strategies, priced honestly.