The Covered Call Stock Option Strategy

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A popular stock option strategy used by investors is the covered call. The covered call is one in which you would write a call option contract for a number of shares of stock you actually own. If you own the stock before writing the call option it is called an overwrite. If you buy the stock as you create the call contract, it is called a buy-write.

 

The stock you own is covering the call option contract which is where the name is derived from. This stock option strategy is generally used when the market is going sideways or you form an opinion that a bull market is developing.

 

With the covered option, the price for the underlying asset has been determined already unlike in a naked option where you don’t own the stock. When the option is uncovered, you will have to go to the market to buy the stock if and when it becomes necessary to cover the option. It is possible to cover your option at any time before the expiration date of the option contract.

 

The covered call stock option strategy is less risky than the uncovered option simply because you already know the price of the underlying asset. The covered call is used to generate income from the underlying asset or stock.

 

You get to keep the premium on the covered call and if the contract expires then you also profit from any gains in the stock value. If the option is exercised you will earn the premium in addition to the difference between the purchased stock price and the strike price. This stock option strategy can also protect you from underlying stock that that may experience a price decline.

 

The breakeven point for the covered call stock option strategy is equal to the stock purchase price less the premium received.

Covered Calls Generate More Income At Low Risk

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Covered calls refers to a low risk options strategy involving an investor owning call options as well as the asset underlying the options. It is probably the lowest risk options strategy that can be devised. The primary purpose is to generate income. The income is generated by selling the call option.

 

Selling call options opens up an investor to the risk of the options being exercised requiring the investor to supply the underlying shares. Under a covered call strategy, the investor already owns the underlying shares largely avoiding any negative consequences from this risk. The share ownership covers, or offsets the risk of, the call options.

 

Under the strategy the investor, by definition, holds a long position in both options and the underlying asset. If the price of the asset rises so that the owner of the options exercises the option and makes a call on the asset, the investor already owns the asset and simply transfers that ownership to the option owner. The investor receives the appreciated price for that asset. Naturally, the investor benefits to the extent that the price of the asset has appreciated.

 

The strategy is also known as a Buy Write strategy. The investor buys the underlying asset and then writes (or sells) the call options. The strategy is used when the investor has a short term neutral to negative view on the asset and for this reason hold the asset long and simultaneously holds a short call option position.

 

An example may help illustrate the strategy. An investor buys one hundred shares in AAA Company at one hundred dollars per share. The investor expects the price of these shares to remain flat or maybe even fall over the next few months.

 

Following the share purchase, our investor also sells ten thousand call options on XYZ shares at thirty cents for each option. The call options have a six dollar strike price and a two month expiry. This call option sale generates a three thousand dollar income for our investor.

 

Three outcomes are possible regarding the XYZ share price over the next two months. Firstly, it will stay constant within a band of five to six dollars. Secondly, it will decrease below five dollars. Thirdly, it will increase above six dollars.

 

In the first two scenarios, the share options expire worthless without their owner making a call on the shares. In both these cases, our investor continues to own the XYZ shares as well as generating a three thousand dollar income from the option sale.

 

In the third scenario, exercise of the call options is triggered. The investor is obligated to sell one hundred AAA shares. Total income from the share sale is ten thousand dollars. The investor also retains the one hundred option sale income.

 

In summary, covered calls offer a low risk strategy to generate additional income from share ownership. Selling (writing) call options does place a cap on the potential share price upside an investor can gain through share price appreciation. However, this is not a major consideration since the cap can be managed by the investor by choosing an option series with an appropriate strike price.

 

Source: Tim Leary

What are the advantages of selling Covered Calls?

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As any investor would know, a call option gives the person the right but not the obligation of buying a stock at the strike price by a certain date. When the stock price goes up, so does the value of the call option. So, the investor would buy the option hoping for the underlying share price to increase. This is one of the many day trading options that investors look out for to increase the returns.

 

One strategy that is often used by investors is to write call options. When the investor hold the underlying share for the option, then it is known as a “covered call”. The buyer of the options pays the additional premium for the right to purchase the stock at the prevailing option price at a stipulated future date. So what are the benefits of selling covered call options? There are basically three main advantages for this strategy.

 

The first one concerns cash flow. Many investors buy the stock with the main objective of selling covered calls. This is an income strategy which is less risky as it is approved by many retirement funds and can provide a steady income. The second advantage is due to hedging. There are times when investors buy the stocks of blue chip as investments for the longer term. However the stock might decline over the short term so investors hedge their position with a covered call. This strategy works when there is little upside or downside potential in the short term but big returns over the longer term. Lastly, there are investors who are looking to sell the stock at a higher price than what it is trading currently. If the stock has been trading at the fair value, the investor can get a higher price if a covered option is sold.

 

Source: Kingdom Calling

Learn about Covered Calls

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For those with a sizable portfolio of common stock there is a low risk trade which uses covered calls. This is a trade that sells call option contracts for immediate cash income. Because you own the underlying stock there is little risk with this type of trade. A great thing about this trading strategy is that it generates instant cash income. This is credited to your account immediately. This cash income makes it a powerful and profitable trading technique that you ought to implement.

 

Investors who have a large stock portfolio are not taking full advantage of the opportunities available to them if they do not execute these trades. Anyone who has a stock portfolio ought to be doing this income generating type of stock market trading. Experts strongly encourage those with a sizable stock portfolio to discuss this with their investment counsellors. It would be a shame to lose the income that you could be earning from doing this.

 

This is a unique type of trade because it is low risk and creates immediate income. It is a trade that can be repeated on a regular basis. Thus, it is a way to constantly create a flow of income into your brokerage account. This is real money that you can spend or invest anyway you please. An investment counsellor can explain all the technical details about how it works. The accounts are simple to open and your investment counsellor can set everything up for you.

 

This is virtually an operation that can run on automatic pilot with minimal stress and concentration on daily stock prices. In fact, even if the market goes down, you are still making income. It is a unique type of trade that anyone who owns a lot of common stock ought to be using on a regular basis. With such low risk and constant inflow of cash income, it is impossible to think of a reason not to be doing this.

 

It is easy to get started with this. Simply tell a broker what you want to do. You can open an account and begin selling call option contracts right away. You will have the peace of mind of knowing that you are earning cash income with little risk of losing anything. It is almost unbelievable how well this type of trading works for building up your net worth.

 

There is no reason to take a chance with risky and complicated investment schemes. Instead, you ought to investigate this conservative way to earn cash with your stock portfolio. The main advantage of this method is that you earn income right away. This is cash that is credited to your account and that you can use anyway you want. In addition, there is little risk with this. The combination of instant cash along with low risk is a powerful combination that you will appreciate.

 

The first step you ought to take in implementing this investment technique is to talk to an experienced and trained investment adviser. They can give you the advice you need to make good decisions with your investments. They can help you avoid common mistakes that those who do not know what they are doing often make. An experienced stock broker or investment adviser can be a big help in making good financial decisions. This is why you should consult with a skilled and talent investment counsellor.

 

Covered calls are a method to utilise your stock portfolio to create a stable inflow of cash income. If you have a sizable portfolio of stock then you should starting using stock option contracts to boost your total investment results. There are investment advisers who will help you get started.

 

Source: Tim Leary

Covered Call Option

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When an investor uses covered call options, the investor sells a call option while owning the stock that is the underlying security of the call options. The stock that is securing the call option may be held by the broker handling the call options.

 

Using this strategy, the investor sells a call option for the same number of shares that the investor owns. A covered call is a fairly common options trading strategy.

 

The covered call option may be called an overwrite if the investor already owned the underlying stock at the time the investor sells the call options. A covered call option is sometimes referred to as a buy-write if the investor sells the call options and purchases the underlying stock at the same time.

 

By selling the call option, the investor is giving the buyer the right to purchase the stocks at the strike price of the option. The writer of a covered call trade often is expecting that the stock will not reach the strike price.

 

If the underlying stocks don’t reach the strike price, the call options the investor sold would expire worthless. The investor would then keep the option premiums as a profit. Any gain in the value of the underlying stock that is still below the strike price could also be considered part of the seller’s profit.

 

If the underlying stock reaches the strike price, the buyer has the right to exercise the option. If the buyer exercises the option, the seller must sell the stock shares to the buyer for the strike price. If the stock price increases drastically, the seller of the call has lost money that the seller could have made by selling the stock on the market.

 

The buyer of the call option makes a profit if the stock price rises above the strike price. The buyer can buy the stock at the strike price which would be less than the market price and sell the stock to get the profit from the trade.

 

The buyer’s risk is limited to the premium paid for the call option. Buying a call option is a common practice for a beginning options investor. While buying a call option has the risk of losing the option premium paid, the potential profit is theoretically unlimited if the stock rallies and makes a major upwards move.

Selling a call option is more risky than buying one because the potential loss for selling a call can be substantial if the stock rallies and the seller is forced to sell the stock at the strike price. The potential loss of a covered call option would be the difference between the strike price and the higher stock market price for the stock minus the option premiums received for the call options.

 

Source: John Mylant

Covered Calls Investment

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Sometimes covered calls are also known as Buy Write. They are a common technique used to trade in shares, foreign exchange, and other securities. In lay terms a cover call is a strategy where an investor holds a long position then waits for an opportunity for him to write call option. If this opportunity avails itself he has a chance of increasing his income.

If you use this tool well, covered call trading strategy has the ability to generate some good profits in the long run of any security. This tool is generally considered safe if not conservative though, it has a number of flaws which we are going to have a look at. We are also going to see all the ups and downs that surround this tool.

Before we continue it will be important to have a few definitions:

A long call option – In this case you buy a contract that allows you to purchase an underlying or a security on or before a specified future date. The price of the security is usually predetermined. This is the strike price. You will have to pay some amount for you to be able to hold this right.

Sell call option – This is an instance where you are the issuer of the long the call option. In this case the person whom you are offering the right pays you. Short the put option. Here you give an investor or trader a right to sell at a future date in which he does not have to sell to you. Basically these are the underlying points in any buy write strategy.

Source: Joe Suttles

Why The Covered Call Strategy Is Considered Safe Investing

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Covered Call strategy, which is a low risk way to earn income from a stock portfolio. The income is earned by writing options. Options are a leveraged investment where you can control a large number of shares with a minimal investment. Leverage allows the investor to obtain a higher rate of return on their investment. However, leverage also has some inherent risks.

As an investor you can buy options or you can write them. There are two types of options: calls and puts. A call option gives the buyer a right to buy one hundred shares of stock at a certain price for a limited period of time. A put option gives the buyer a right to sell one hundred shares of stock at a certain price for a limited period of time.

The price that you can either buy or sell the shares is called the strike price. The cost of the option is called the premium. Call option prices go up and down in tandem with the underlying shares of stock. Put option prices go up and down in the opposite direction of the underlying shares of stock.

If the owner of the option decides to exercise their option, the option writer will have to sell their shares of stock to holder of the option. This will incur a minimal loss. It is easy to see how this is a conservative investment approach for the option writer. There are ways of offsetting the deal to protect the option writer.

With leverage the investor has the potential to earn a higher rate of return on their investment. This is because they are only putting up a fraction of the full cost of the shares. The risk of using leverage is that the investor can be wiped out faster if there is an unexpected drop in share prices.

With leverage there is the possibility to make a greater rate of return on your investment. On the other side of the coin, a small price fluctuation can render your options worthless. For the writer of the calls options, the chances are that the option will never be exercised. If the price of the underlying stock does increase, the write of the option can always purchase an option to offset the transaction. This is what makes this such a safe investment.

When an investor has a large stock portfolio they can constantly be writing options to have a continuous flow of income. Since they already own the shares this is a relatively risk free income generating technique. Not all option techniques are as safe as this one is. There are very complex transactions that are put together by professional investors and hedge funds. The ordinary investor does have to concern themselves with these to earn a nice flow of income.

Using the covered call strategy is an easy and safe way to earn some income from a stock portfolio. Not all common stocks are listed on the option markets. For this reason, if you are interested in using this technique make sure the equities you buy are listed on the options exchange. A stock broker who specialises in options may be able to assist you.

Options Trading: Writing Covered Calls

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One of the reasons I like investing in dividend stocks is that I feel that they are inherently less risky than non-dividend paying stocks. Each time a dividend is received, a small gain on your invested capital is ‘locked in’. However, in volatile markets, price fluctuations can be significantly greater (in percentage terms) than any dividends received. To help combat drastic swings in valuation, and to augment the income received from dividends, I’ve adopted a strategy of writing covered calls on suitable long positions.

Writing Covered Calls:
Writing covered call options can be thought of as getting paid for writing a limit sell order. As with a limit-sell order, a sell price is specified when the options order is entered which limits the maximum achievable capital gain when the contract is in force. If this sell price is not met when the option expires, you keep the options premium received (free money!) and the stock. The difficulty in implementing a covered call writing strategy is determining a personally acceptable maximum potential rate of return over the duration of the contract in relation to the options premium received.

Prerequisites:
As each call option represents 1000 shares of the underlying security, a covered call writing strategy can only be adopted on long positions involving at least 1000 shares. In addition, your brokerage account must also be approved for options trading.

Determining an Appropriate Options Series:
Determining what options series to open is highly subjective and is based on a number of factors unique to each investor such as the commission required to write options, the desired annualized yield from options premiums, and the minimum annualized capital appreciation. To determine the options series that I write for each of my positions, I use the following guidelines:

1.) Expiry Month
The expiry month of the options series determines how long the options contract will be in force. As an options’ time value decreases as it approaches expiry, writing contracts with an expiry far in the future will increase the options premium received for each contract. However, as the time value of options decays more rapidly the closer you are to expiry, the annualized options yield (premiums received per year) can be greater by writing options with expiries in near months (up to three months out).

My rule of thumb for most stocks is that using an expiry date three months into the future tends to provide a balance in terms of capital appreciation potential, options premium received, and trading commissions.

2.) Strike Price
The strike price of the option series sets the maximum price that you can ‘sell’ the stock for as long as the options contract is in force. In choosing a strike price, I look at the worst-case total return (capital gains over the life of the contract plus options premium received less commission) of the stock over the two to three month period to expiry.

In general, I tend to write out-of-the-money options with strike prices that allow a total return (not including dividends) of between 5-6% over the length of the options contract.

3.) Options Premium
As compensation for limiting the potential for capital gains over the length of the options contract, I want to receive at least a 5% annualized options yield (net of commission) on each position I write covered calls on. Ideally this yield would be higher, but with small positions (writing 1-2 calls at a time) commissions significantly reduce the options yield.

After examining a stock’s call option chain, if I cannot identify an expiry month and strike price that will provide an the annualized options yield greater than 5%, and a worst case total return (less dividends) of greater than 7%, I will not write the contract. Instead, I will wait until a more volatile market (options pricing increases with market volatility) and then enter into the position. Otherwise I do not feel adequately compensated over the duration of the options contract for the potential of lower capital gains.

Performance of Options Strategies:
Writing covered calls on open long positions will generally under perform the market in strong uptrends, but outperform the market in downtrends, flat markets, and provide equivalent returns during modest uptrends. By underperforming during strong uptrends and outperforming in downtrends or flat markets, the overall year-to-year highs and lows in the portfolio will be closer together resulting in lower portfolio volatility.

Over a number of market cycles, the total long-term return of covered call writing should at least equal that of straight buy-and-hold investing. However, the income generated by a portfolio active in writing covered call will be significantly greater than that of the buy-and-hold investor. This can allow for more frequent reinvestment of dividends and options premiums which can help to increase the overall compound growth of a portfolio.

Understanding the Basics of Covered Calls

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Despite what the mainstream media would have you believe not every option trading technique is risky. Did you know that writing covered calls is often considered to be one of the safest, most conservative investment strategies available to the average investor? If you needed any further evidence of just how conservative this strategy is it should be noted that you can even sell covered calls within your individual retirement accounts. Perhaps the main reason why people have the erroneous belief that options are risky is simply because they do not understand the basic terminology involved.

When an investor decides that they want to start selling covered call there are just a few things they need to get started. The first thing they need to do is get permission to trade options from their Option broker. Most online platforms allow options trading by default so this typically involves reading a short pamphlet and then signing a form stating that you know what you are doing. After that, all you need is to own at least one hundred shares of the underlying stock for every call option that you want to sell.

Selling a call option essentially means that you are agreeing to sell a specific number of your shares of stock to another investor at a predetermined price. If the buyer exercises their rights to buy your stock you are then obligated to sell it to them at the strike price regardless of what the current market value of the stock is. This is perhaps the main reason you will always want to be in a covered position. In this instance, being covered simply means that you have a sufficient quantity of stock to sell the buyer without having to go into the stock market and buy it.

Of course, the seller would never agree to sell the rights to their stock if there was not something in it for them as well. Anytime an investor buys an option that must pay the seller a premium. This premium is based upon numerous factors such as how much time is left until the expiration date and how close the current market price of the underlying stock is to the strike price of the option. The premium income that the seller receives is what makes this technique so profitable.

Savvy investors know that most options that are held until the expiration date will expire with no value. As such, selling covered calls against stock positions that you already own is a very lucrative investment strategy when executed correctly.

Bought Strangles – Monitoring Trades

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Once you have placed the trade it is important to monitor the progress of the trade. The main things to watch are the share price, strangle option value and the breakevens. If there share price increases quickly and the call option is at breakeven.

Do Nothing

Analyse the chart and workout the next resistance level. If your view on the share price is that it will continue to increase stay in the strangle. The risk here is that if the share price decreases the profits on the bought call with disappear.

Free Trade

If your outlook on the share price is that it will fall from the current levels. This may be indicated through bouncing off a resistance level or being overbought. You can sell the call option and receive all your initial investment or more and keep the bought put as a free trade. Whatever you close out the bought put will be additional profit.

Rolling the strangle

This is the preferred strategy. Rolling the strangle allows you to close out the profitable leg for breakeven or more. Buy a new strangle at the new levels and have a free put. This trade should be able to be done for a small credit so risk is not increased actually decreased from when the trade was placed. If the share price continues to decrease the call option will continue to profit. If the share price fall the trade will profit quickly as there are twice as many put options. This strategy works extremely well as you are always in the market and continually having free option legs. If there is an unexpected move this strategy will have a substantial profit.

To receive ASX Option Recommendations or to learn more about straddles and strangles please request the complete Straddles and Strangles eBook by contacting us on07 5504 2244 or info@totaloptions.com.au