How to Use Options with ETFs for Additional Income

6 January 2025

Investing in the stock market can sometimes feel like trying to navigate a jungle—you’ve got stocks, bonds, ETFs, cryptocurrencies, and everything else thrown into the mix. But one area that often flies under the radar for many casual investors is the idea of combining options trading with ETFs (Exchange-Traded Funds). Sounds fancy, right? Don't worry, it’s not as intimidating as it sounds. In fact, by the end of this article, you'll see it for what it really is: a smart way to potentially generate additional income.

So, grab a cup of coffee (or tea, no judgment here), and let’s dive into how you can use options with ETFs to put a little extra cash in your pocket.

What Are ETFs? A Quick Refresher

Before we jump into options, let’s lay the groundwork with ETFs. Simply put, an ETF (Exchange-Traded Fund) is like a basket of stocks or bonds packaged together for investors to buy or sell on the stock market. You can think of it as a sampler platter at your favorite restaurant—when you buy an ETF, you’re essentially buying a piece of multiple stocks or other assets all at once.

For example:
- The SPY ETF tracks the S&P 500 index, meaning you get exposure to all the big public companies in one shot.
- The QQQ ETF is focused on tech-heavy companies in the NASDAQ 100.

ETFs are great because they provide diversification (spreading out the risk), low costs, and the ease of trading them just like you’d trade a regular stock.

But here’s the kicker: owning ETFs on their own doesn’t pay you much beyond dividends (if there are any). This is where options swoop in to save the day and juice up your income potential.

What Are Options? Let’s Break It Down

If ETFs are the sampler platter, then options are like the seasoning you can sprinkle on top. Options are financial contracts that give you the right, but not the obligation, to buy or sell an asset (like a stock or ETF) at a specific price by a certain date.

Think of options like buying a ticket to a concert. The ticket gives you the right to attend the event (buy or sell the ETF), but you’re not obligated to go (you could simply let the option expire).

Two main types of options exist:
1. Call Options – This gives you the right to buy the ETF at a specific price.
2. Put Options – This gives you the right to sell the ETF at a specific price.

Still with me? Great! Now, let’s connect the dots between ETFs and options and see how this combo can generate additional income.

Strategy #1: The Covered Call Strategy

Alright, let’s start with one of the most popular ways to earn income using options with ETFs—the good ol’ covered call strategy.

What’s a Covered Call?

A covered call involves selling a call option on an ETF you already own. Essentially, you’re agreeing to sell the ETF at a specific price (called the strike price) if the buyer of the option exercises it. In return for making this agreement, you earn a premium (aka income).

Here’s a quick example:
Let’s say you own 100 shares of the SPY ETF. You sell a call option with a strike price of $450, and the buyer pays you $2 per share as the premium. That’s $200 in your pocket (100 shares x $2).

What’s the catch?
If the ETF’s price climbs above $450 before the option expires, you’ll have to sell your shares at the strike price of $450—even if they’re worth more at that point. But hey, you still get to keep the premium income, which cushions the blow. Not a bad gig, right?

Strategy #2: Selling Cash-Secured Puts

Now, let’s flip the script with another strategy—selling cash-secured put options. This method is for folks who are looking to buy ETFs at a discount while earning income in the process. Sounds like a win-win, huh?

How Does It Work?

When you sell a put option, you’re essentially agreeing to buy the ETF at a specific price (the strike price) if the option is exercised. In exchange for taking on this obligation, you earn a premium upfront.

Let’s break it down with an example:
Imagine you’ve got your eye on the QQQ ETF, which is trading at $370. You’re okay owning it for $350, so you sell a put option with a strike price of $350. The buyer pays you a $3 premium per share (that’s $300 if it’s 100 shares).

What happens next?
- If the ETF’s price drops to $350 or below, the option gets exercised, and you’ll have to buy the ETF at $350—which is what you wanted anyway. Plus, you’ve already pocketed that $300 premium.
- If the price stays above $350, you keep the $300 premium, and you don’t have to buy anything. That’s free money, my friend!

Why Options with ETFs Are a Great Match

Still wondering why options and ETFs go together like peanut butter and jelly? Here’s why:

1. Low Volatility: ETFs are generally less volatile than individual stocks, which makes options strategies less risky.
2. Diversification: Because ETFs hold a mix of assets, you’re not putting all your eggs in one basket.
3. Liquidity: Many popular ETFs have a ton of trading volume, meaning their options are liquid and easy to trade.

Risks to Watch Out For

Let’s pump the brakes for a second. While options can be a powerful tool, they’re not without risks. Here are a few things to keep in mind:

1. Limited Upside with Covered Calls: If the ETF’s price skyrockets, you might miss out on those gains since you’ve capped your sell price at the strike price.
2. Capital Requirements for Selling Puts: Selling cash-secured puts requires enough cash on hand to buy the ETF if the option is exercised.
3. Option Expiry: If you’re not careful, options can expire worthless, leaving you with nothing but regrets. Timing is key.

So, while options can generate extra income, it’s important to understand what you’re signing up for and have a clear strategy in place.

Tips for Success When Using Options with ETFs

Ready to up your game? Here are some handy tips to help you succeed:

1. Choose the Right ETFs: Stick with ETFs that have high liquidity and consistent trading volume. Popular ones like SPY, QQQ, or IWM are great places to start.
2. Start Small: If you’re new to options, don’t go all-in right away. Experiment with a single covered call or put option to get the hang of it.
3. Use Longer Expirations: For more stable income, consider options with longer expiration dates. Short-term options can be more volatile.
4. Monitor Your Trades: Keep an eye on your options trades and adjust them as needed. The market can change quickly, so stay proactive.

Wrapping It All Up

Using options with ETFs is like giving your investments a side hustle—it’s a way to earn a little extra income without completely overhauling your strategy. Whether you're selling covered calls to make money on ETFs you already own or selling cash-secured puts to buy ETFs at a discount, these strategies can give you more control over your portfolio and a nice income boost.

Sure, options might seem like a complicated puzzle at first, but once you understand the pieces, it’s not so daunting. And hey, even if you mess up the first time, it’s all part of the learning process. So, why not give it a shot? You just might surprise yourself.