Writing covered call is one of the most popular strategies that many expert traders as well as traders new to options trading use to generate income. The strategy is popular for two reasons:
- It is a conservative strategy
- It is easy to understand and trade
For those who are unfamiliar with the covered call strategy, it works in the following manner. For every 100 shares of a particular stock that you already own, you can sell someone the right (no obligation) to buy those shares from you at a certain fixed price (strike price) before an expiration date. The amount that you get from writing (selling) the call is called premium.
At the expiration, if the stock ends up above the strike price, you will be obligated to give away your shares at the agreed price. If the stock ends up below the strike price, the option expires as worthless, and you will be able to retain the ownership of your stock, which you can again use to write the covered calls.
While covered call writing is a straightforward option strategy, it does not mean it is easy to make excellent returns consistently. The strategy has two major risks:
- When the price of the underlying stock takes a big leap, you will miss out on gains above your strike price because the buyer will exercise the option and you will have to sell at a price, which is below market price.
- When the value of the underlying stock falls substantially, the loss from holding your stock will probably exceed the gain from the premium income.
Because of such risks, it is crucial to select a proper trade plan. Randomly selecting stocks on which to write covered calls or selecting certain stocks simply because they have high premium will probably lead to failure.
Here are two important criteria for selecting the best stocks on which to write covered calls:
Select stocks with good technical. There is no need for you to become a technical analyst in order to be successful with covered call strategy, but knowing the basics of technical analysis is helpful. If you are going to be making short-term trades, it is essential to have some kind of basic understanding of technical analysis or access to some tools and resources, which can help you to determine the short to intermediate term technical health of a stock. By knowing the technical health of a stock, you can also determine its covered call suitability.
Select stocks with realistic premiums. If you are going to be writing covered calls for income, you will want to pick stocks (technically healthy) with a good amount of premium so that it be worth your while. Good premium does not mean high premium, but realistic premium. Options with very high amount of premium are dangerous ones. They have high volatility and uncertainty. No matter how big returns they yield, these types of stocks are not fit for reliably successful covered call strategies.
Covered calls strategy can be an excellent resource to generate income. However, just because it is easy to understand and to trade does not mean it is easy to execute on a consistent basis. Fortunately, there are various resources available that can help improve your covered call returns; for instance, the experienced advisers at Total Options. Covered calls Australia advisors at Total Options have the skills as well as vast experience that help them give you excellent advices that can improve the performance and returns on your covered calls. Know more about them by visiting their website http://totaloptions.com.au/