Selling Covered Calls

earnpassively | Nov 29, 2010 |

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Many investors are under the erroneous belief that option trading somehow exposes them to more risk than when using more traditional investment techniques. While it is certainly a fact that speculative options strategies do exist there are a few techniques that have proven themselves to be both financially profitable and conservative while also providing limited downside protection in a declining market. Selling covered calls is perhaps the most well known, and used, options trading technique used today.

Options were originally developed to help reduce an investor's risk due to unseen factors. As investment brokerages started slicing these strategies up into variations of its original intent laws were passed to protect the common investor. Before being able to invest in any form of option you are required by law to read "Characteristics and Risks of Standardized Options". Despite being seen as risky when you sell covered calls you are actually decreasing your downside risk.

What Are Covered Call Options

A call options is simply a contract where they seller agree to sell 100 shares of their stock to a buyer for a certain price if the option is exercised on, or before, a certain date. The term covered refers to the fact that the seller already owns sufficient shares of the underlying stock which they could then sell to the buyer if they are called to do so. When you sell covered call options you actually reduce your potential liability since you would not have to go out and buy the stock (at the current market price) if your call was exercised.

Why Investors Sell Covered Calls

Covered calls provide the investor with the unique ability to be able to invest their funds in the stock market and to profit while holding them. With a traditional buy-and-hold strategy the only time an investor could realize a profit would be if they sold their stock. When you sell covered call options you can actually earn additional income without ever having to sell your stock.

What Are the Risk of Writing Covered Calls

Like all investments, writing covered calls involves some risk. If the underlying stock loses a significant amount of value over a relatively short period of time you may have a hard time selling a call next month above your cost basis. This is particularly true if you have purchased the underlying asset recently. Furthermore, selling calls against your stock positions also serves to effectively cap the amount of money you can make on your investment. If the stock doubles in price you still have to sell it to the buyer at the agreed upon price.

What Are the Benefits of Using Covered Call Strategies

Covered calls are fast becoming the investment choice of thousands, if not hundreds of thousands, of investors across America. In addition to receiving premium income instantly when you sell the call it also provides a small amount of downside protection if you stock should happen to decrease in value. The more premium income you receive the lower your overall basis in the stock becomes making it much easier to exit the transaction at a profitable level.

If you are looking for a safe, conservative, and profitable investment technique to help supplement your portfolio income consider selling covered calls.