Covered Call Strategy – Best Way To Use Covered Calls 5 comments

Nov 13, 2012 10:18 AM

A lot of investors and novice traders are just unaware of the many possibilities options provide. Most start with just trading shares of stock in companies and never expand their knowledge outside of that realm.

One of the most common strategies taught to most investors and traders starting out in options is called the covered call strategy or buy-write.

A covered call strategy utilizes both stock and that same underlying’s option contract. This strategy is taught to help most long term investors enhance their return on investment by selling call option contracts.

The covered call strategy is pretty simple to create in your brokerage account. Let’s say you own 1,000 shares of that company. Since one stock option contract represents 100 shares of that underlying issue, you would want to sell 10 call option contracts.

This is why the strategies term covered means since the trader owns shares of that stock. By selling a call option, the trader is giving someone the right to purchase their stock at the strike price on or before expiration in exchange for a premium.

You would typically sell a call option contract at a higher strike from where the current price of the stock is trading.

1. Generate income on existing stock positions
2. Create downside protection
3. Enhance gains

1. Limited upside reward
2. Obligation to sell stock
3. Tax consequences

TWO THINGS CAN HAPPEN DURING THE COVERED CALL STRATEGY :

1) The price of your stock goes higher and goes above the strike of the call contract you sold. What will happen is the stock will get called away or sold at that option contract strike you sold and you collect the profit from when you purchased the stock and the price it was called away at. You will also take in the premium you collected when selling the call option contract on top of the profits you already have from the stock moving higher.

2) The price of the underlying does not move into that strike of the call option you sold by expiration of that option. You still own the stock of the company and you also have the premium you collect from that option contract.

This is a win-win situation because most would just hold the stock while waiting for it to move higher. If the price of the stock does move higher and you get the stock called away while doing the covered call strategy, you still win by locking up profits and then going back out and buying shares again and selling option contracts above the current underlying’s price.

Risk/Reward. Substantial/Limited

Max Gain. Strike Price — Stock Purchase Price + Premium

Max Loss. Stock Purchase Price — Premium (same risk as just owning stock, but minus premium you collected)

Breakeven. Purchase Price of Stock — Premium

I share with you my best information on using the covered call strategy that most people don’t even think of.

Now Watch The Video On The Covered Call Strategy

If you are interested in seeing how to exactly do this with a twist, then you will want to watch the video below.

I share with you my best information on using the covered call strategy that most people don’t even think of.

Comment below and tell me know if you have had success with the covered call strategy. Also, tell me how you plan on using this strategy in the future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors’ articles.