As interest rates continue to hover at ridiculously low levels, many savvy investors have begun writing covered calls to supplement their monthly income. Covered calls allow investors to generate additional income by selling the right to buy a portion of their stock to another investor at a certain price at some set date in the future.
In many ways the covered call strategy can be considered less risky than simply owning shares of stock. Of course, this truly depends on how aggressive, or conservative, this technique is implemented.
What are Call Options
A call option is simply a contract between two investors in which the seller of the option agrees to sell a portion of their stock to the buyer if the buyer elects to do so on, or before, the expiration date. In exchange for essentially giving up the rights to their stock, should it rise above the strike price, the seller receives a cash premium from the buyer. This premium income stays with the seller regardless of what happens to the price of the underlying stock.
Potential Outcomes When You Sell a Call Option
Most covered call writers will tell you that writing covered calls typically is most effective in relatively flat, or slightly rising, stock markets. In these types of market conditions, the seller generally receives more income from collected premiums than the potential gains that are forfeited by being called out of the position.
If the price of the underlying stock remains at, or below, the strike price at expiration, the investor (that is, the seller) banks the additional income from selling the option and gets to hold onto the stock. They are then free to sell another call against the same shares next month to generate even more income. If the price of the stock has declined significantly, the covered call writer’s loss is reduced by the amount of premium income they collected; effectively reducing their cost basis.
If the price of the underlying stock rises above the strike price at expiration, the seller must sell the agreed upon number of shares to the buyer at the strike price; even if the current market price is significantly higher. The seller does get to keep the premium income and the cash that is generated from the sale of the stock.
Mastering the Covered Call Strategy
While it is certainly true that selling covered calls is a great way to generate additional income from an existing stock portfolio, there are many variables that need to be carefully considered.
If you have ever wanted to start writing covered calls, you may want to check out The Options Trading Experts. With your free trial, you get access to all the covered call searching, filtering, email alerts, options, and portfolio management tools you can handle.
There are no tricks and absolutely no gimmicks. If you are not completely convinced that you can generate additional income every month by writing covered calls, you can cancel it with absolutely no charge.