Aside from dividend shares, genuine passive income isn’t easy to come by. But there’s a strategy I’ve been considering recently involving options.
Selling covered calls can be a way of generating extra income from a portfolio of stocks, even if they don’t pay dividends. So is it something I should start doing in 2026?
What are covered calls?
Call options allow someone to buy a particular stock at a specified price (the strike price) before a certain time. And one way to make money is by selling these to someone else.
Doing this without owning the stock in question is one of the fastest ways to blow up a portfolio. But the risk is much more limited for someone who owns the shares themselves.
The share price can go up past the specified price on the option and in that situation, the investor has to sell it below its new market value. And that results in missed returns.
If this doesn’t happen, though, the investor gets to keep whatever premium the buyer pays for the option. And that looks like it can be a valuable source of passive income.
An example
As an example, I own Amazon (NASDAQ:AMZN) shares in my portfolio. Right now, I can sell, for $108, a call option with a $250 strike price that expires at the end of January.
That means I get $108 right now. And if the share price stays below $250 (it’s currently $232) until the end of the month, nothing happens other than I keep the cash as passive income.
If the stock goes above that level – suppose it reaches $260 – I’ll have to sell it at $250. So my potential profit until February is limited to 7.75% plus the $108 I get for selling the option.
A US option represents 100 shares, so $108 is another 0.45%. And that’s the equation I have to weigh up – a 0.45% guaranteed return to limit my profits to 8.2% until the end of the month.
Should I do it?
I think the stock market underestimates Amazon in two ways. Two of these are the strength of its advertising platform and its artificial intelligence (AI) potential going forward.
The firm’s advertising business has been growing strongly and its Trainium chips are more efficient than their Nvidia counterparts. These look like impressive growth avenues to me.
The biggest risk is Amazon’s AI infrastructure spending. The stock market is just starting to question whether the company’s capital commitments on this front are going to pay off.
My own view is that the share price adequately reflects these risks. That’s why it’s on my buy list and why I don’t plan on selling covered calls to try and generate extra income.
Risks and rewards
The passive income generated by selling call options could help reduce my losses if Amazon shares fall in the next month. And I’m definitely not ruling this out as a possibility.
Selling covered calls, though, isn’t a strategy I want to pursue right now. Being able to benefit from rising share prices is an important part of my investing plan.
Forgoing this on a temporary basis by selling options might seem like an attractive idea. But if I’m right about the stocks I own, it’s something I could live to regret in the long term.
