Writing covered call options can provide an excellent opportunity to build a monthly income stream just from owning a stock. The only requirement for trading covered calls are that you own at least 100 shares of a security (1 option contract equals 100 shares of stock). You also need to make sure that the security has enough volume and liquidity to have options offered. You can quickly check this by looking at any financial website that offers stock quote information.
Are you interested in learning more information on writing covered call options? If you are, be sure to check out the 5 tips below to help get you started.
- Invest In What You Know - This is nothing new to the average investor, but writing covered call options should be no different than purchasing a stock. It is critical to carry this strategy forward if you choose to trade covered calls. If you don't know what a company sells or the industry they are in, then stay away from the stock or go out and research what the company does.
- Factor Your Risks - As with any investment, you should factor all potential risks into your decision making process. Ask yourself what is the worst thing that could happen? What will it take to break even? Writing covered call options is much less risky than other strategies, but there are still some risks to consider. For example, since you are "covering" your investment with shares you own, you need to understand that you could be forced to sell the stock at the strike price if the buyer calls the contract. Make sure yo are comfortable with this before selling any covered call contract.
- Owning the Shares - Do you own at least 100 shares of the underlying stock you plan to write a covered call option against? In order to make this trade, you are required to own the shares so you are "covered" in teh event the buyer "calls" the contract. Make sure you are comfortable with owning these shares in your portfolio.
- Out of the Money - The most effective strategy to use when writing covered call options is to find contracts that are at least one to two strike prices out of the money. Ideally, you don't want to have the shares "called", so you want to sell the contract out of the money. The money you make will be lower than selling a call at the money or in the money. However, it is hard to predict what the market will do, so adding a little buffer is a smart strategy. Please be aware that selling a covered call contract out of the money does not completely insulate you to market upswings.
- A Month or Two Out - In addition to writing covered call options out of the money, it is also a good idea to keep the contracts no more than one or two months out. You don't want to give the market enough time to move the share price of your stock up. As a result, selling covered calls that have shorter terms lowers your risks.
Trading covered call contracts can provide an excellent opportunity to earn additional monthly income. Combinging an income stream from selling covered calls with a dividend paying stock can be a great way to build a long lasting and stable income stream. There are however some risks that all investors should be aware of before placing any trades.
It is important to always conduct your due diligence before making an investment. Remember that you are responsible for your own actions, so never rely on others to decide for you!