Covered Call Options to Generate Extra Income
When most investors hear the term options trading, they turn the other way because options trading is only for the expert investors. While it is true that options trading can get complex and risky, some types of options trading are relatively easy to master even for the basic investor. One of the simplest forms of options trading is called the covered call.
In general terms, a call option gives the owner of the call the right to buy a certain stock at a certain price (called the strike price) on or before a certain date (the option expiration date). You can either buy a call or sell a call depending on what you are trying to accomplish. The topic of this article is actually the selling of a call option as an investment strategy, and this is known as selling a covered call.
Let’s say you have 200 shares of ABC Company in your investment account that you bought for $50 per share. Your investment in this company is $10000. For argument’s sake, let’s say you have a long term outlook on this stock but you would also be willing to sell this stock for $60 per share, because that is a nice return - $10 per share. At present your strategy is to wait until your stock reaches $60 per share and collect any dividends along the way. However, what you could also do is sell covered calls along the way to earn extra revenue.
Options have different life cycles, usually starting at 1 month but going up to several years. Options that have an expiration date of more than 1 year are called leap options. Options are traded in blocks of 100 shares of stock and each block is called a contract. In our example, you bought ABC Company for $50 per share and you discover you can sell a leap covered call option for $60 per share expiring in about a year for $5 per contract. The cost of each contract is $500 ($5 X 100) and since you own 200 shares, you could pocket $1000 right now by selling 2 covered call contracts for ABC that expire in 1 year. It is called a covered call because you own the stock to fulfill the contract.
The upside is you get an extra $1000 right now for your stock. You can also collect any dividends along the way as well. The downside is that you are tied to this option for 1 year, meaning that you have given the buyer the right to buy your shares at $60 at any time within this 1 year period. If ABC Company never reaches $60 per share within the year, the option expires and you are no longer bound by it. However, if ABC reaches $60 or higher, your option will be called and your stock will be sold for the $60 strike price. Either way you still keep your $1000 from selling the 2 covered call contracts.
While this is a simple example of selling a covered call, it should be easy to see how employing a strategy of selling covered calls could be a good way to generate extra revenue for stock you were planning on holding. Like any investment there is risks and rewards. In most cases you probably want to stick to selling covered calls on companies you are comfortable with and also have a good track record of appreciation - probably the reasons why you own the stock in the first place.
There is a lot of information in books and on the internet related to trading options. Reading and understanding it can be daunting. However, if you employ simple strategies that you understand, such as the selling of covered calls, you can also put a little extra money in your account along the way.
When most investors hear the term options trading, they turn the other way because options trading is only for the expert investors. While it is true that options trading can get complex and risky, some types of options trading are relatively easy to master even for the basic investor. One of the simplest forms of options trading is called the covered call.
In general terms, a call option gives the owner of the call the right to buy a certain stock at a certain price (called the strike price) on or before a certain date (the option expiration date). You can either buy a call or sell a call depending on what you are trying to accomplish. The topic of this article is actually the selling of a call option as an investment strategy, and this is known as selling a covered call.
Let’s say you have 200 shares of ABC Company in your investment account that you bought for $50 per share. Your investment in this company is $10000. For argument’s sake, let’s say you have a long term outlook on this stock but you would also be willing to sell this stock for $60 per share, because that is a nice return - $10 per share. At present your strategy is to wait until your stock reaches $60 per share and collect any dividends along the way. However, what you could also do is sell covered calls along the way to earn extra revenue.
Options have different life cycles, usually starting at 1 month but going up to several years. Options that have an expiration date of more than 1 year are called leap options. Options are traded in blocks of 100 shares of stock and each block is called a contract. In our example, you bought ABC Company for $50 per share and you discover you can sell a leap covered call option for $60 per share expiring in about a year for $5 per contract. The cost of each contract is $500 ($5 X 100) and since you own 200 shares, you could pocket $1000 right now by selling 2 covered call contracts for ABC that expire in 1 year. It is called a covered call because you own the stock to fulfill the contract.
The upside is you get an extra $1000 right now for your stock. You can also collect any dividends along the way as well. The downside is that you are tied to this option for 1 year, meaning that you have given the buyer the right to buy your shares at $60 at any time within this 1 year period. If ABC Company never reaches $60 per share within the year, the option expires and you are no longer bound by it. However, if ABC reaches $60 or higher, your option will be called and your stock will be sold for the $60 strike price. Either way you still keep your $1000 from selling the 2 covered call contracts.
While this is a simple example of selling a covered call, it should be easy to see how employing a strategy of selling covered calls could be a good way to generate extra revenue for stock you were planning on holding. Like any investment there is risks and rewards. In most cases you probably want to stick to selling covered calls on companies you are comfortable with and also have a good track record of appreciation - probably the reasons why you own the stock in the first place.
There is a lot of information in books and on the internet related to trading options. Reading and understanding it can be daunting. However, if you employ simple strategies that you understand, such as the selling of covered calls, you can also put a little extra money in your account along the way.