In the world of investing, stocks and bonds are probably the best-known investment vehicles. In fact, stock ownership is often touted as one of the many ways for the average American to get rich, and many of us own them – either directly, or indirectly through other market products like mutual funds. I believe in stock investing, particularly the buy-and-hold philosophy, but I think that there are others ways to power your investment portfolio without taking on an excessive amount of risk. For instance, you could sell covered calls.
I already gave a brief overview of stock options and option trading in a previous article, wherein it was explained that a call was a right to buy a particular stock at a certain price (known as the "strike price") within a particular time period. You can actually buy or sell calls. In fact, selling calls can be quite lucrative.
When you sell a call, you’re offering to sell stock to someone at a particular price. If you own the stock already, then the call you sold is known as a "covered" call; it’s "covered" because you already own the underlying stock and will not have to purchase it in order to make good on the sale, if necessary. (By contrast, you’ve sold a "naked" call if you sell a call for stock you don’t own, which can leave you open to significant liability.) Let’s take a look at how this works:
Assume you own 100 shares of Coca-Cola, which is priced at $63 per share in October. You’re willing to sell your shares for $63, but why not make a little extra money? Looking at November, you see that the November $63 call is selling for $1. Thus, you could sell one contract of the November calls and make an extra $100 on your Coca-Cola shares – assuming the price of the shares stays above the strike price of $63. (The concepts of contracts and strike prices, among other things, were discussed in the earlier article.) Basically, the call buyer will exercise his option and buy your shares if the price is above $63. (Why will he buy if the price is above $63? Because he can buy your shares at $63 and immediately sell them for a profit!) If the share price is lower than $63, you keep the $100 you earned selling the call, and you still own your Coca-Cola stock (meaning that you can do the whole thing again – and again – until you actually sell). You can use this strategy even if you don't really want to sell your shares of a particular stock, as long as you understand that such a sale could still occur.
In brief, while I have not addressed every scenario that can be encountered from selling calls, you can see how selling covered calls can produce a nice little income stream on the side. (Imagine, for instance, having 300 shares of Coca-Cola; or 500; or 1000.) Of course, this particular scenario assumes that you have enough shares of a particular stock to start with, and you must understand that you may be required to sell them. (You could, of course, sell naked calls – which don’t require ownership of the underlying stock – but that subject will be addressed in a later article.) Needless to say, you should perform adequate research before pursuing any options strategy, including the sale of covered calls (which is considered to be a conservative options strategy).