Covered Call Options Pay Immediate Income

by Wes Bridel on May 20, 2011

in Stewardship

Selling Covered Call Options

We’ve been discussing put options, but will now turn our attention to call options.  A very similar approach can be taken to the strategy we’ve already discussed when you already own the shares underlying the option.  In this case, you Sell Covered Call Options to produce extra income.  This is considered a very low risk strategy because it definitely reduces the risk of owning the stock.  The downside is that it eliminates some of the potential upside of owning a stock if the stock dramatically appreciates in value so that you make a smaller predetermined amount on the stock and option.  Let’s look at how it works…

If you own 100 shares of Intel and would like to receive more income than the company is currently paying in dividends, you can sell 1 Call Option contract against the shares.  This is called a “Covered Call” because the option sale that you are obligating yourself to will be fulfilled with shares which you already own.  If you sold the Call Option without owning the stock, this would be a “Naked Call Option”.  In this case, if the price rose sufficiently, you would be obligated to sell shares which you don’t own.  You would have to go buy the shares in order to sell them and would lose money on the trade.

In a Covered Call Option sale, you know ahead of time everything that can happen, and since you already own the underlying shares, every possibility is a profitable one to you.  (The value of the stock could fall to zero and you could lose everything that you invested into the stock, but this was already the case because you had previously taken on this risk by buying the security.)

In the next couple posts on this topic, we’ll again explain exactly how this works so that you find it easy to lower risk and increase your income selling covered calls.

This is Post 9 of a new series on stock options which we’ll be revisiting every few days.  You can find the first few parts at the following links: Pt 1, Pt 2, Pt 3, Pt 4, Pt 5, Pt 6, Pt 7, & Pt 8.

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