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Covered Call Options Strategy – “Call” Your Bluff

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Introduction

 

 

A covered call is an option strategy that can help investors earn additional income on securities like stocks or ETFs that they already own.

Many investors sell covered calls because they have lower risk than other options strategies.

And in this lesson, we will be discussing the covered call options strategy in greater detail – as we analyze the pros, cons, risks, rewards, and most importantly, how to profit whether you win or lose the trade.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Covered Calls Basics

 

 

A covered call strategy involves an investor owning or buying shares of stock and selling call options, often at a strike above the stock’s current price in order to collect a premium.

If the stock’s price rises above the strike price of the sold option, and the option is exercised, the covered call writer is obligated to sell the stock at the strike price.

 

 

If the stock price does not rise up to the call’s strike price, or decline by more than the premium received, the trade can make money.

For example, suppose there’s an investor who owns 100 shares of stock at $100 per share.

After analyzing the stock’s price movement and trend, the investor doesn’t think the stock price will rise much in the next few months. So they decide to sell a call option with a strike price of $105 on their stock.

For selling this option, they earn $300. Now, depending on what the stock does, one of two things will happen.

As long as the stock price doesn’t rise above $105, the option will expire, and the investor keeps their stock.

However, if the price goes down, they could lose money on their stock, but any losses could be partially offset by the option premium, less and commissions and fees.

 

 

In other words, you will win the trade and recollect your premium – but you don’t want the stock to fall to much since you DO own the stock and any fall in the stock price could make you lose money. The “cover” is that you can make money via the premium that you get to keep.

But if the stock does move higher than $105, the option would likely be exercised, and the investor would be forced to sell their shares.

However, they still profited from the shares increasing in price plus the option premium, less commissions and fees.

 

 

But keep in mind, there is a risk of missing out on further gains if the stock goes up any further. There is also the risk of the stock’s price going down – but that can happen any time you own a stock.

A covered call doesn’t just bring in income on stock you own. Some investors buy stock and sell a covered call at the same time. This is called a “buy-write”, and it can help lower the effective cost of purchasing the new stock.

 

 

Let’s look at an example.

An investor is interested in a company that is trading at $100 per share. The investor decides to buy 100 shares for $10,000.

If they write a covered call at the same time, they’ll earn a $500 premium, reducing the cost to $9,500 plus commissions and contract fees.

Now suppose they were able to write a covered call every month and receive a similar premium amount each time. As long as the stock price stays below the strike price of the covered call, the premium they’d earned over time, less commissions and fees, would help make up for some of the cost of the stock.

Of course, there is no guarantee that a covered call writer can consistently accomplish this month after month. Short options can be assigned at any time prior to expiration.

 

 

If you’re interested in learning about other options strategies, we’re here to help. Take a look at more of our binary option education here at Invest In Wall Street.

Quick Recap

In Review….

Covered Called Basics

 

  • A covered call strategy involves an investor owning or buying shares of stock and selling call options, often at a strike above the stock’s current price in order to collect a premium
  • If the stock’s price rises above the strike price of the sold option, and the option is exercised, the covered call writer is obligated to sell the stock at the strike price
  • If the stock price does not rise up to the call’s strike price, or decline by more than the premium received, the trade can make money
  • But they could lose money on their stock, but any losses could be partially offset by the option premium, less and commissions and fees
  • In other words, you will win the trade and recollect your premium – but you don’t want the stock to fall to much since you DO own the stock and any fall in the stock price could make you lose money. The “cover” is that you can make money via the premium that you get to keep
  • But if the stock does move higher than the strike, the option would likely be exercised, and the investor would be forced to sell their shares. However, they still profited from the shares increasing in price plus the option premium, less commissions and fees
  • But keep in mind, there is a risk of missing out on further gains if the stock goes up any further. There is also the risk of the stock’s price going down – but that can happen any time you own a stock
  • A covered call doesn’t just bring in income on stock you own. Some investors buy stock and sell a covered call at the same time. This is called a “buy-write”, and it can help lower the effective cost of purchasing the new stock

 

 

 

And this is the basics of covered calls. In this lesson, we have covered one of the most popular options strategies to date.

In order to properly execute this type of trade, you would first have to gain possession of the stock you are placing an option on. You will then choose a options contract with the strike price that you desire and write (sell) a call. The idea behind this theory is to protect you in the case that if the stock that you own were to decrease in value, you would still be able to make money by keeping the credit that you made by selling the shares.

In order to win the trade, your option contract would have to expire below the predetermined strike in order for you to keep the premium. However, since you do own the stock that you have placed the option on, you are still entitled to the same risks that come with stock ownership. This means that if the stock were to fall in value, you will lose money per share – but it is with the option premium that you win that can offset any stock downswings that you have experienced.

If the stock were rise above the strike at the time of expiration, then the option would be “exercised” and the investor would be forced to sell their shares – and ultimately lose the trade. However, since you do own the shares of stock, you can still profit via stock appreciation. Hence, the name “Covered Calls’.

In the next lesson, we will be discussing how to trade covered calls, along with the various ways to profit from this strategy.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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