The options strategy called Covered Call Writing is a conservative strategy designed to reduce risk and increase profits when investing in stocks. Briefly stated, stock option contract which you buy or sell the right to buy or sell. Although there are eight types of options contracts, we are interested here in low-risk "Covered Call Writing."

Here's how it works: Say it's August and you buy 300 shares of stock XYZ at the price of $ 48 per share. XYZ pays a quarterly dividend of 50 cents per share. Therefore, if the price is not never moves, you'll earn 4.2% per year.

At the same time, I would like to join the Covered Call Writing. To do so, you, you would "write three January 50 calls." This means that you are selling ("writing") to the right for someone else to buy the stock from you (they "call" it away) between now and the third Friday of January of the specified price of $ 50 . (All contracts expire on the third Friday of the month.)

Each contract represents 100 shares, so the three contracts represent 300 shares. Consumers have to pay a fee (called a "premium") of $ 3.5 per share, or $ 1050. (Premium is based on the amount of time until the end and the spread between current prices and the "strike price" in this case $ 50. Therefore, the premium changes constantly.)

Assuming no need to cancel, only two things can happen next: The contract will get exercised or it will expire worthless in January. Either way, you keep $ 1050. Obviously, this strategy can yield great rewards. Among the advantages are:

1. You are establishing a profitable day price to buy sell stock. If exercised, you are guaranteed a profit;

2. You reduce risk for premium in effect it reduces the price you paid for the stock;

3. Your annual yield is boosted far above that of the dividend alone.

However, there are other considerations. For one, you are limiting your potential revenue. No matter how high the stock rises, you will not sell for over $ 50. You can solve this problem by buying back your choice, in effect you canceled it. Options typically are not listed as a strategy for penny stocks for dummies stocks to buy.

Also, do not you reduced the risk that your stock can drop the price. The only certainty is, XYZ should drop $ 25, your options are not exercised - a small consolation. To protect yourself, you can "buy the January 45 put" giving you the right to sell your stock for $ 45. This is the opposite of what we've reviewed here, and it is designed to minimize losses, rather than protect gains.

Given the potential for price drops, you should choose a high quality, blue-chip stock that fits your budget, where they offer more of a stable trading range, solid core, high dividends, and excellent growth potential. Penny stocks are not such a good idea in this instance.

Covered Call Writing is not a reason to own stocks, but the approach can be of help if you already own them. Before opening an account, you receive and urged to read the "Characteristics and Risk of Standardized Options," which is published by the Options Clearing Corporation in cooperation with the NASD and all major U.S. stock exchanges . The booklet is available from any broker or financial adviser.