How would you like to earn cash on the stocks you already own?
Sounds like a pretty sweet deal right?
Enter in the covered call.
This strategy is used regularly by the Big Boys of Wall Street because they know that it will provide consistent paychecks every single day.
The best part is that it’s not very complicated at all.
You don’t have to be an expert in options to use this easy money making strategy.
But for some reason, a lot of traders don’t know about this or choose to just ignore this really simple income strategy.
Causing them to miss out on the opportunity to make some easy profits.
What is a Covered Call?
Covered calls are an options strategy that you use when you hold a long position on a stock and you write a call option on that same stock.
For example, say you own 100 shares in Apple stock that are currently valued at X dollars.
Now you have the right to sell your stock at any time for the market price.
You can also sell those rights to someone else with what is known as a “call option.”
You still own those 100 shares, but you have given the buyer of the call option the right to buy your shares at the agreed upon price point.
This price point is commonly known as the strike price.
So here’s the meat, covered calls typically have two components:
- Ownership of the stock you want to use with a covered call.
- The sale of call options that are equivalent in amount against the stock.
When should you use covered calls?
This strategy is best implemented on a stock you want to hold long-term, but the market is in a short-term neutral-to-bearish movement.
Now is the time to sell a covered call option.
One big reason is that it will help to offset the cost of the original stock price purchase while you wait for the market to turn.
There’s no point in wasting that time watching the stock price move back and forth.
When you can be using that time to make a quick profit.
Don’t worry, I will give you a real world example of how to make these profits in just a bit.
Having this short position via the option will generate quick income for your portfolio via the covered call premium.
The premium is the fee that the buyer of your call pays you in order to keep your stocks open to him for purchase at the Strike Price.
As always, using a real life example is the best way to illustrate how to effectively use this strategy.
How to use a covered call
Let’s say I own 100 shares(it has to be in sets of 100) of Intel stocks that I purchased at 20 dollars per share.
According to the chart below we can see that the current market conditions are not trending in a bullish direction for this particular stock.
In order to gain some profits and offset my slow moving stock, I decide to sell a covered call contract for my shares.
I am allowed to sell 1 contract per 100 shares that I own.
Since I currently own 100 shares I can only purchase 1 call contract.
Next I head over to the call/put section of my trading platform to check out the available contracts.
I am using ThinkorSwim as my platform and here is an example of the options I have available for my 100 Intel shares:
Here we see that I can potentially make .21 cents per share over the next two weeks with a strike price of $36.
The strike price is the point where the buyer of my call option now has the right to purchase my stock at that price point up until it expires on April 7th.
Which again, in this situation, is $36.
You don’t have to pick a two week expiration date.
There are many different options with different Strike Prices so you can choose the one that best fits you.
Covered Call Results
Now one of three things can happen:
- My Intel shares trade flat (below the $36 strike price) – which means the option will expire on April 7th, rendering it worthless, and I still keep the premium from it.
- My Intel shares could fall. Again this means that the option will expire and I get to keep the premium. I have also, just offset some of my immediate losses by lowering each shares cost by $0.21 per share.
- My Intel shares could rise to the $36 Strike Price and the buyer of my covered call could exercise his right to purchase my stocks.
Option 1 ends up happening and I get to keep the premium AND my shares.
But now I have just lowered my initial investment cost from $20/share to $19.79/share.
It doesn’t seem like much now, but over time it will begin to build up giving you potentially massive profits.
Things to Consider when trading a Covered Call
I recommend only using this strategy on stocks that you are ready and willing to buy.
The power of this approach won’t be effective if you end up holding onto a bunch of dead end stocks.
At the end of the day you want these stocks to add long term value to your portfolio.
Another thing that you should factor in when trading a covered call is commission.
If the amount of the commission will erase a significant portion of the premium received, then it isn’t worth your time selling the option and creating a covered call.
A Covered Call:
- Provides protection in a bear/sideways market
- Is one of the few ways an index investor can achieve double-digit returns in a flat or slow-growth market.
- Lowers your cost basis while decreasing the volatility of your portfolio.
Remember, covered calls make you money when stocks are slightly higher, sideways, or in a downward trend.
The only downside is if the purchased stock is “called” away because the price rises to the strike point.
I still make a profit on my stocks since I bought them at $20/share.
But I no longer own the stock, therefore giving up my potential for profits in the future.
Overall this strategy is typically safer than buying an actual stock.
So why would any trader choose to pass up such a proven income strategy that has so much potential for profits?
I hope this article on Covered Calls has helped you and given you a new strategy to utilize in your arsenal.
ps if you want to learn more about options then tap here to grab my FREE options report.