How To Write Covered Calls

Writing covered calls is a conservative investment technique that has helped many of our nation's wealthy become even more wealthy. While most people automatically assume that any options trading strategy is risky, selling covered calls is actually so safe that it is allowed in your retirement IRA. Covered calls writing, in fact, is the only options technique that can claim this distinction.

Things You Will Need

In order to write covered calls, you need to own 100 shares for each call you plan to sell. It is easier, but not required, if your online trading platform allows you to buy 100 shares and sell 1 call at the same time.

Step 1 Understand Option Terminology

The term 'covered call' simply means that you own at least 100 shares of the underlying stock for which the call was written. When you sell a call, you are selling the right, but not the obligation, to buy your stock at a certain price on, or before, a certain date to someone else.

Being covered means that if the options were to get exercised, you would already own the shares needed to deliver to the buyer. If you did not own the shares, this would be calling selling 'naked' calls, and is an extremely aggressive strategy employed by only the bravest of professional investors.
Step 2 Sell The Call - Typically, covered calls can be written in one of three ways:

1. Buy 100 shares of the underlying stock and immediately sell 1 call against it. This is the most conservative strategy since you are not trying to time the market.
2. Sell a call against shares of stock that you already own. If you own shares of stock, you are leaving money on the table by not 'renting' them to speculators.
3. Buy 100 shares of the underlying stock and then sell the call at some point in the future. Again, this is a market-timing strategy that is most often used by professionals only.
Step 3 Writing Covered Calls - An Example

Let's assume it is the first of January and you want to sell1 call of ABC stock. After logging onto your online broker, you place an order to buy 100 shares of ABC stock at $10, and immediately sell 1 $10 February call against those shares. You receive a premium of $0.50 a share, or $50, for doing so. This money is yours no matter what happens to the price of your stock.

Once the option expires (on the 3rd Friday of February), three scenarios are possible:
1. The price of the stock stays below $10. You will not be called out. As such you still own the stock, earned $50 in premiums and are free to sell another call against these shares.
2. The price of the stock rises above $10. You will be called out of your shares. As such, you will receive $1,000 ($10*100) and get to keep the $50 in premiums earned. You are now free to take you $1050 and invest it other covered calls, or anything else you want.

Writing covered calls is an extremely conservative and useful technique for turbo-charging your portfolio's performance.

Tips & Warnings

You can lose money using any investment technique. Practice on paper for a few months before committing real money to selling covered calls.