Writing covered calls is an investment strategy for options
trading that can super-charge your overall return on investment.
This simple strategy is very conservative and actually reduces
risk while providing additional income.
The main benefits of writing covered calls are: 1. Create
monthly income. 2. Increase your return. 3. Reduce your risk.
These are three great reasons your plan should include covered
call trading options.
The practice of writing covered call options involves buying a
security (stock, commodity, forex future, etc.) and immediately
selling a call option, on a share for share basis, against the
underlying security. The premium received for selling the call
is considered income by the seller of the call (also known as
the call writer).
Covered Call Writing Example Assume that it is November 15th,
and a stock investor buys 100 shares of XYZ at $29 a share. His
total investment is $2900. The investor immediately sells an XYZ
DEC 30 Call for 2.00.
This option gives the call buyer the right to buy 100 shares of
XYZ Stock from the investor at $30 a share any time before
December expiration. For this right, the option buyer pays the
stock investor a $200 premium. The investor gets to keep this
premium, thus creating income, no matter what happens to the
stock.
What happens if the stock goes up? Let's say XYZ goes up to 35
on good news. The call buyer exercises his option on December
15, forcing the call writer to sell him his stock at 30 (he's
been assigned or called out). He bought the stock at 29 and
receives $100 profit from the increase to 30. He also gets to
keep the $200 premium. The total profit on his $2900 investment
is $300. The Return on Investment is 10.3% ($300/$2900). The
total time in this position was 1 month.
The investor has received his original investment, plus a profit
on the stock price increase, plus the premium. He now has $300
more to invest in a new position for the following month.
What happens if the stock goes down? This time, let's say XYZ
goes down to 25. The call buyer does not exercise his option to
buy the stock at 30. The option is uncalled and expires
worthless. The call writer gets to keep the $200 premium and
keep the stock. Even though the stock price fell, he still makes
income of $200 on his $2900 investment.
The Return on Investment is 6.8% ($200/$2900). The total time in
this position was just over 1 month.
The investor is now free to write another call for the following
month, receiving additional premium or income.
Covered call writers often hold onto stocks after a decrease and
continue to generate additional income by writing more calls.
They continue this strategy until the stock returns to a price
where they can sell the stock at a gain.
Tired of watching the stock in your portfolio move up, down and
sideways? Write covered calls against stocks you already own to
generate monthly income. Manage your positions carefully so you
don't get called out of stock you want to keep. New Insights on
Covered Call Writing, by Richard Lehman and Lawrence McMillan,
is a great book that will teach you how to do this.
For even better results, try trading options in ira accounts.
You will want to speak with your accountant about tax
considerations. Options trading rules are quite complex, but
deferring your taxes will obviously allow your winnings to
compound even faster.
About the author:
Steve Rosenbaum is a former Chicago Mercantile Exchange employee
who brings professional tools and strategies to the home
investor. Visit
http://www.options-trading-resources.com/Artic0001 for stock
option and trading information for beginning traders and pros
alike.
