Covered calls writing is the best options strategy for those investors who are looking for a way to generate income in neutral market conditions. It is a conservative, less risky, easy-to-understand and easy-to-trade strategy.
Those who are unaware of the covered call strategy, here is a brief. For every 100 shares that you already own for a certain stock, you can sell (write) someone the right to buy those shares at a predetermined price before a predetermined expiry date. For that, you get a certain amount of money on the spot, which is called a premium. However, remember, you are only selling the right to someone to buy your shares; you are not enforcing any obligation on someone to buy your shares.
At the expiration, if the stock surpasses the predetermined price (it is called the strike price), you will have to sell your shares to the buyer of your option contract. As said above, the buyers of your shares have the right; hence, if the buyers wish, they can exercise the contract and buy your shares. In case the stock fails to reach the strike price, which often happens, your option expires worthless, and you will retain the ownership of your shares.
While the strategy is pretty straightforward, it is not always easy to yield good returns consistently. Covered calls writing has two risks:
- If the price of your stock, against which you have written covered calls, surges up, you will miss on the gains because the buyer will exercise the option and you will have to sell your shares at the strike price, which now is below the current market price.
- If the price of your stock drops abruptly, the loss from holding your shares will exceed the gains from the premium income.
In the light of this, it is important to choose a good trade plan. Choosing stocks arbitrarily to write covered calls or choosing stocks only because they have a high premium will most likely lead to failure.
Below are two important aspects, for choosing the proper stocks on which you can write covered calls:
Pick stocks with a strong technical. To be successful with the covered call strategy, you do not need expert-level technical analysis skills; however, basic knowledge of technical analysis is helpful. Technical analysis shows how the stock will perform in the short term. Therefore, get some basic understanding of the technical analysis. Online tools and resources are available, so it would not be too difficult.
Pick stocks with pragmatic premiums. When writing covered calls for income, it is essential to pick technically healthy stocks with a good premium. Good premium does not mean high premium or low premium, but pragmatic premium. Option contracts with high premium are dangerous, as they tend to have high volatility. No matter how attractive the returns may seem, stocks with high premiums are unfit for the covered call strategy.
Writing covered calls is an excellent strategy to produce income in flat market conditions. Nonetheless, just because it is straightforward to trade does not mean it is easy to execute it consistently. Fortunately, there are resources available to help improve your returns through covered calls. For instance, check out the skilled advisers at Total Options. The advisers at Total Options specialise in covered calls Australia. They can give excellent ASX options advice that can help improve the returns through covered calls writing. Learn more about Total Options by visiting their site www.totaloptions.com.au