Passive income through option writing: Part 1

On the path to early retirement (and most likely in early retirement as well), the ERN family will be writing options to generate passive income (in addition to equity and real estate investments, of course). This may be something that people either haven’t heard before or even if they did, they might be turned off by the involvement of derivatives. After we got over our initial aversion against trading exotic instruments like options we found that it’s actually a reliable and profitable strategy to generate passive income. We mentioned this strategy already in a previous post on trading derivatives on the path to FIRE and thought that others might find this interesting too.

Today, in Part 1, we will do a quick intro to cover mostly the conceptual aspects of this strategy. Part 2 will go into how we actually implement our strategy. As a warm up, though, let’s start with a …

Pop Quiz:

Since 2000, the SPY ETF (S&P500 index fund from iShares) returned about 101% (Dec 1999 to August 2016, dividends reinvested), or about 4.3% p.a. What would the return have been if we had participated only when the market went up, i.e., if we had avoided every single down month and received a 0% return during that time?

A: 386% total, 10.0% annualized

B: 1,039% total, 15.7% annualized

C: 2,497% total, 21.6% annualized

D: 3,891% total, 24.8% annualized

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