Understanding Covered Calls
Most people who are invested in the stock market do not know that they can generate cash flow from their positions. The idea was first introduced to me back in'98 by a fellow trader. The strategy is called covered call writing. Covered call writing is considered so safe that even brokerage firms that manage IRA accounts allow you to write covered calls.
The strategy is very similar to selling an option on a piece of real estate. For example, I'll give you $10,000 now, if you allow me to buy your property 6 months from now at a set price. If I choose not to exercise my option, you keep the money and we go our separate ways.
With a stock, let us say I buy 1,000 shares of ABC OIL at $10 and the stock goes to $11 in the following month. I can sell someone the "right" or option to buy the stock from me six months from now at $12.50. For that right or option, the option buyer has to give me some consideration, similar to the above real estate example, let's assume it is .50 per share or $500.
The $500 is deposited into my brokerage account immediately. My brokerage company will not allow me to sell my stock prior to 6 months unless I buy back the option on the open market. With big fluctuations in option prices, I usually hold my stock until the expiration date.
Six months from now, two things can happen. First, the stock can go above $12.50 and the buyer of the option "calls" me out of the position which I happily do since I bought the stock at $10. The second thing that can happen is that the stock falls below $12.50 and the option holder is holding on to a worthless option. No option holder is going to "call" you out of the stock if it is $12.50 when he can buy the stock in the open market for $11.50 a share.
You then start the process all over again by writing another call against your position.
So let me back up. What exactly did I do here? First, I hedged my position by 5% or $500. Second, I set a strict target price that I was willing to let the shares go for, $12.50. Finally, I created immediate cash flow that I could use for my daughter's birthday or reinvest.
This strategy has made me very happy in bear markets because most options expire worthless and I get to keep my stock and what the option buyer originally paid me for the option!
There are a variety of software programs available that will let you spot the best stocks to buy, then write covered calls against. Of course you do not need any software. The software just saves you some research time.
As a reminder, make sure you "know what you own" and consult with a tax professional or adviser before investing your hard earned money! - 23199
The strategy is very similar to selling an option on a piece of real estate. For example, I'll give you $10,000 now, if you allow me to buy your property 6 months from now at a set price. If I choose not to exercise my option, you keep the money and we go our separate ways.
With a stock, let us say I buy 1,000 shares of ABC OIL at $10 and the stock goes to $11 in the following month. I can sell someone the "right" or option to buy the stock from me six months from now at $12.50. For that right or option, the option buyer has to give me some consideration, similar to the above real estate example, let's assume it is .50 per share or $500.
The $500 is deposited into my brokerage account immediately. My brokerage company will not allow me to sell my stock prior to 6 months unless I buy back the option on the open market. With big fluctuations in option prices, I usually hold my stock until the expiration date.
Six months from now, two things can happen. First, the stock can go above $12.50 and the buyer of the option "calls" me out of the position which I happily do since I bought the stock at $10. The second thing that can happen is that the stock falls below $12.50 and the option holder is holding on to a worthless option. No option holder is going to "call" you out of the stock if it is $12.50 when he can buy the stock in the open market for $11.50 a share.
You then start the process all over again by writing another call against your position.
So let me back up. What exactly did I do here? First, I hedged my position by 5% or $500. Second, I set a strict target price that I was willing to let the shares go for, $12.50. Finally, I created immediate cash flow that I could use for my daughter's birthday or reinvest.
This strategy has made me very happy in bear markets because most options expire worthless and I get to keep my stock and what the option buyer originally paid me for the option!
There are a variety of software programs available that will let you spot the best stocks to buy, then write covered calls against. Of course you do not need any software. The software just saves you some research time.
As a reminder, make sure you "know what you own" and consult with a tax professional or adviser before investing your hard earned money! - 23199
About the Author:
Do not buy any stock trading education materials until you see Lance Jepsen's free stock market blog at how to invest in stock market, and learning the stock market
posted by X - Men @ 3:49 AM
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