Tuesday, March 5, 2013

Options: Selling Covered Calls

Selling covered calls is a neutral options trading strategy. One of the best techniques to learn when trading stocks is selling covered calls. Selling covered calls means that there are investors willing to pay for the right to take a stock if it reaches a much higher price. Selling a call requires that you have at least 100 shares of a stock. It is an excellent stock market strategy to implement while waiting for a stock to reach your identified sell point. This technique can be used repeatedly, and it can be a great way to create income.




For example, say that you purchased 500 shares of ABC Corp in 2000 for $25.50 per share. Since the current price is $26.00, you have basically broken even in six years. While you didn’t know what would happen during that time, you still could have been making money on your investment by selling covered call options against your shares. This would have allowed you make money even though your investment was sitting around doing basically nothing. You have 500 shares, so you can sell five options, since options must be sold in groups of 100. In this example, you are going to sell out-of-the-money (OTM) covered call options. This means that the stock has a strike price (the target price for the buyer) which is higher than the current price. The covered call that you are selling has a strike price of $30.00 per share and a premium of $ 0.25. Since you have 500 shares, the five covered call options that you sell will bring in a total of $125.00. This technique works well and only a substantial move higher forces you to sell.
By selling covered calls, you are able to accumulate income passively over time by collecting the premiums on your options. If your option doesn’t reach and maintain the strike price during the time period, the premium and the stock are yours. If you get assigned on your options and are forced to sell your covered calls, it is even better. When the $30.00 strike price is met, not only did you receive $125 from the premiums, but you also have a gain on the stock from your original purchase price of $25.50. That turns into a $2,250 profit.
Selling covered calls is an excellent stock option trading strategy, but it is no substitute for technical analysis and learning how to read stock charts. If you purchase a stock on a strong upward trend and someone forces you to sell your covered calls, you no longer have the stock and you are missing out on its upward climb. If you want to continue holding stock in this company, you must buy again and you will be forced to pay a higher price for it.

Selling covered calls is a great way to make money on your favorite holdings while you wait for them to trend upward.



There are many options trading strategies in addition to selling covered calls that you should learn including buying puts, selling calls, and the buy strangle, just to name few.

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