The Truth About Covered Calls
Most investors do not understand how to generate cash flow from their stock positions. Covered calls can be used to hedge your stock positions. My stock advisory newsletter first introduced to me the strategy of covered calls. I was shocked to discover that even major IRA accounts ran by brokerage firms allow you to write covered calls because of its relative safety to other option strategies.
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. One, the stock goes above $12.50 and the person "calls" me out of the position, which I am more than happy to do since I bought it at ten. Second, the stock has declined below $12.50 and the option holder is holding on to a worthless option. The option holder would not "call" the stock from me at $12.5 when he or she might be able to buy it in the open market at $11.50.
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 covered call writing strategy makes you a lot of money in a falling market because most option contracts keep expiring worthless and so you get to keep all your stock plus what the buyer of the option originally paid you.
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.
But remember, any option strategy involves more risk than just buying a stock so always consult with a licensed financial adviser first. - 23167
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. One, the stock goes above $12.50 and the person "calls" me out of the position, which I am more than happy to do since I bought it at ten. Second, the stock has declined below $12.50 and the option holder is holding on to a worthless option. The option holder would not "call" the stock from me at $12.5 when he or she might be able to buy it in the open market at $11.50.
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 covered call writing strategy makes you a lot of money in a falling market because most option contracts keep expiring worthless and so you get to keep all your stock plus what the buyer of the option originally paid you.
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.
But remember, any option strategy involves more risk than just buying a stock so always consult with a licensed financial adviser first. - 23167
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 @ 3:51 AM
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