Covered Calls For Income
A covered call is an income-producing strategy where you sell, or “write”, call options against shares of stock you already own. Typically, you’ll sell one contract for every 100 shares of stock. In exchange for selling the call options, you collect an option premium. But that premium comes with an obligation. If the call option you sold is exercised by the buyer, you may be obligated to deliver your shares of the underlying stock.
Fortunately, you already own the underlying stock, so your potential obligation is “covered” – hence this strategy’s name, “covered call” writing.
Writing covered calls is an excellent source of income for investors and short term traders alike. Widely viewed as a conservative strategy, professional investors write covered calls to increase their investment income. Individual investors also benefit from this simple, yet effective strategy by taking the time to learn it. By doing so, investors will add to their investment knowledge and give themselves additional investment opportunities as well as downside protection for stocks.
A “covered call” is an income-producing strategy where you sell, or “write”, call options against shares of stock you already own. Typically, you’ll sell one contract for every 100 shares of stock. In exchange for selling the call options, you collect an option premium. But that premium comes with an obligation.
Why write covered calls?
When you sell covered calls, you’re usually hoping to keep your shares of the underlying stock while generating extra income via the option premium. You’ll want the stock price to remain below your strike price, so the option buyer won’t be motivated to exercise the option and grab your shares away from you. That way, the options will expire worthless, you’ll keep the entire option premium at expiration and you’ll also keep your shares of the underlying stock.
If your stock’s price is neutral or dropping a bit, but you still want to hold onto the shares longer-term, writing covered calls can be a good way to earn extra income on your long position. But remember, you’re also a stockholder, so you’ll most likely want the value of your shares to increase – just not enough to hit your covered call’s strike price. Then you won’t just keep the premium from the options sale, you’ll also benefit from the shares’ rise in value. You’re really loving life if that happens.
Because covered call writers can select their own exit price (i.e., strike plus premium received), assignment can be seen as success; after all, the target price was realized. This strategy becomes a convenient tool in equity allocation management.
The investor doesn’t have to sell an at-the-money call. Choosing between strike prices simply involves a tradeoff between priorities.
The covered call writer could select a higher, out-of-the-money strike price and preserve more of the stock’s upside potential for the duration of the strategy. However, the further out-of-the-money call would generate less premium income, which means there would be a smaller downside cushion in case of a stock decline. But whatever the choice, the strike price (plus the premium) should represent an acceptable liquidation price.