How to make money selling covered call options

The worst that can happen is that they are called to sell the stock to the buyer of the call at a price somewhere below the current market price. For more information on covered call writing, read Covered Call Strategies For A Falling Market. Most financial advisors will tell their clients that, while this method can be a very sensible way to increase their investment returns over time, it should probably be done by investment professionals, and only experienced investors who have had some education and training in the mechanics of options should try to do it themselves. Therefore, if the stock is called, the seller simply delivers the stock already on hand instead of having to come up with the cash to buy it at the current market price and then sell it to the call buyer at the lower strike price. Therefore, if the stock price stays the same or declines, Harry walks away with the premium free and clear. Investors who purchase a call option believe that the price of the underlying stock is going to rise, perhaps dramatically, but they may not have the cash to purchase as much of the stock as they would like. The closer the option is to expiring, the lower its time value, because it gives the buyer that much less time for the stock to rise in price and produce a profit. Investors who write or sell covered calls get paid a premium in return for assuming the obligation to sell the stock at a predetermined strike price. This conservative approach to trading options can produce additional revenue, regardless of whether the stock price rises or falls, as long as the proper adjustments are made. The possibility of triggering a possible reportable capital profit makes covered call writing an ideal method for either a traditional or Roth IRA.

There are no hard and fast parameters that show how profitable this can be, but if done carefully and correctly, it can not difficult increase the overall yield on a stock holding by at least a percent or two per year. The strike price is the price at which the buyer of a call can purchase the shares. If Harry in the above example were to repeat this method successfully every six months, he would reap thousands of extra dollars per year in premiums on the stock he owns, even if it declines in value. Therefore, this method is not available for bond or mutual fund investors. His research indicates that the price of the stock is not going to rise materially any time in the near future. But writing covered calls is an excellent method of generating extra investment income when the markets are down or flat. Covered call writers also retain voting and dividend rights on their underlying stock. Options also have two kinds of value: time value and intrinsic value. They will get fewer premiums but will participate in some of the upside if the stock appreciates.

This allows the investor to simply buy back the stock at an appropriate price without having to worry about tax consequences, as well as generate additional income that can either be taken as distributions or reinvested. Learn about option basics in our Options Tutorial. For an alternative to covered calls, take a look at our article about Adding A Leg to your option trade. One of the best features of writing covered calls is that it can be done in any kind of market, although doing so when the underlying stock is relatively stable is somewhat easier. Although the method can be somewhat involved, covered call writing can provide a means of generating income in a portfolio that cannot be obtained otherwise. In addition to having to deliver your stock at a price below the current market price, getting called out on a stock generates a reportable transaction. This can be a major issue to consider for an investor who writes calls on several hundred or even a thousand shares of stock.

There are other issues to consider as well, such as commissions, margin interest and other transaction fees that may apply. Covered call writers are also limited to writing calls on stocks that offer options, and, of course, they must already own at least a round lot of any stock upon which they choose to write a call. With its continued infiltration into the media world, T stock is shaking itself out of the doldrums of telecom. Even though it has sunk recently, it presents a good opportunity to both buy the stock and sell covered calls against it. American success stories that just keeps moving higher. When it comes to covered calls, you have two approaches: The first is a hedging method if you think a stock may be selling off, but you want the security in your portfolio. As of this writing, he has no position in any stock mentioned. You keep the premium no matter what. MSFT stock has performed admirably. TWX purchase does give it some juice.

Plus, it has a consistent dividend. At the time these prices were taken, RMBS was one of the best available stocks to write calls against, based on a screen for covered calls done after the close of trading. If used with margin to open a position of this type, returns have the potential to be much higher, but of course with additional risk. This traditional write has upside profit potential up to the strike price, plus the premium collected by selling the option. Read on to find out how this method works. Option premiums were higher than normal due to uncertainty surrounding legal issues and a recent earnings announcement. Also, the potential rate of return is higher than it might appear at first blush.

RMBS closed that day at 38. This was the case with our Rambus example. We can begin by looking at the prices of May call options for RMBS, which were taken after the close of trading on April 21, 2006. These conditions appear occasionally in the option markets, and finding them systematically requires screening. Any upside move produces a profit. Therefore, we have a very wide potential profit zone extended to as low as 23. Covered Call Strategies For A Falling Market. That may not sound like much, but recall that this is for a period of just 27 days. Find out about another approach to trading covered call.

But there is very little downside protection, and a method constructed this way really operates more like a long stock position than a premium collection method. The maximum return potential at the strike by expiration is 52. Selling options to other people is how many professional traders make a good living. We use modern web design principles to make your choices clear and not difficult to understand. Our software is fast. You can try everything we have free for two weeks. It is our belief that you can make money with covered calls by keeping the software and process simple. Why Born To Sell? Our software saves you time.

Our Portfolio features take care of this for you. The covered call method is conservative in nature, consistent in its ability to generate recurring monthly income, and simple to execute. Our software is not difficult. Most covered call writers spend a great deal of time creating and updating a custom spreadsheet they use to track their positions. Check out our features. Anyone who owns stock can sell covered calls against their shares for extra income. You never have to push a Search button and wait for an entire new page load to see the results. And our Top 10 page shows you the most popular covered calls. Plus weeklys, updating prices during market hours, rolling calculator, income goal, etc.

We have a free trial. The facts show that most stock options held until expiration expire worthless. As the striking price is lower than the price paid for the underlying stock, any upward price movement will not benefit the call writer since he has agreed to sell the shares to the option holder at the lower striking price. Profit is limited to the premium earned as the writer of the call option will not be able to profit from a rise in the price of the underlying security. ETF options, index options as well as options on futures. No amount of call writing can protect you from a 231 point drop in 5 months. Before investing, go to a couple of your favorite financial news sites and enter the stock symbol.

Or, heaven forbid, you have been losing money with covered calls. Stocks tend to rise when there are rumors of buyouts. An investor has to be extremely disciplined when investing with borrowed money. But many other times the use of margin will simply amplify your losses and lead to a quicker ruin. Maybe okay to buy some shares if you have an exit plan with a fairly tight stop loss of money order in place, but covered calls are not the right method for that situation. If you are writing deep in the money calls on thinly traded issues and are happy having them called away at expiration then maybe you can invest in these stocks. While some ETFs are good for conservative portfolios and can lower volatility through diversification, other ETFs should be avoided at all costs for covered call writing. But because they are thinly traded they can be quite volatile, in addition to having wide spreads. Everyone likes a good story stock.

For volatile situations, keep positions extra small. Looking back, no one knew when the momentum train would stop but everyone knew that eventually it would. They are not to be held for weeks or months for covered call investing. Capital Wealth Planning Interview, Coastwise Captial Group Interview, and Van Hulzen Interview. Better to have a small profit or loss of money and live to fight another day than to get wiped out in one or two large bets that go wrong. Born To Sell Wins! Risk management is the key to long term investing and survival. For those of you who are making too much money with covered calls, we have put together a list of ways that you can use to quickly give some back.

There are times when that can be a winning method. Great way to win big if it hits. Those would be the 2x and 3x leveraged ETFs. If the majority of my covered call trades are profitable, why am I unable to outperform the major market index? And be sure to check out our Zacks Options Trader. Without auditing his trading journal, I could foretell the problem.

While neither one is completely avoidable, following a few simple steps can help minimize losses and reduce equity drawdowns. Streaks tend to occur during major market corrections and can ravage a covered call portfolio. If an upside profit is limited, then a downside loss of money should be limited too. He overlooked risk management. One way to neutralize this risk is through portfolio diversification. The answer is quite simple: risk management. One should also trade a few uncorrelated trading strategies.

How much did you earn last year trading covered calls? This is a very simple remedy; nonetheless, it yields a more acceptable and more manageable number. Many covered call traders fall in love with their stocks and plan to hold their positions into perpetuity. You receive a premium for selling the option, but most downside risk comes from owning the stock, which may potentially lose its value. Check for news in the marketplace that may affect the price of the stock. The goal in that case is for the options to expire worthless. If you are selling covered calls to earn income on your stock, then you want the stock to remain as close to the strike price as possible without going above it. The sweet spot for this method depends on your objective. Selling the call obligates you to sell stock you already own at strike price A if the option is assigned. Do yourself a favor and stop getting quotes on it. That way, the calls will be assigned.

That will decrease the price of the option you sold, so if you choose to close your position prior to expiration it will be less expensive to do so. You want the price of the option you sold to approach zero. You still made out all right on the stock. After the method is established, you want implied volatility to decrease. Static Return assumes the stock price is unchanged at expiration and the call expires worthless. If Called Return assumes the stock price rises above the strike price and the call is assigned. That means if you choose to close your position prior to expiration, it will be less expensive to buy it back. View the Option Chains for your stock. Remember, if something seems too good to be true, it usually is. Covered calls can also be used to achieve income on the stock above and beyond any dividends.

Beware of receiving too much time value. Of course, this depends on the underlying stock and market conditions such as implied volatility. For this method, time decay is your friend. If you want to sell the stock while making additional profit by selling the calls, then you want the stock to rise above the strike price and stay there at expiration. Volatility Trading Volatility allows you to purchase a stock and program a sell order in your online trading account which will sell the stock once the price rises a specified amount. Wall Street secret used largely by savvy Hedge Fund managers. The key is knowing which stocks to hold for selling covered calls and which to invest in for the long term. The income from selling the rights is referred to as the premium.

Covered Calls: The Hidden Wall St. Some of these trades are made by financial institutions like Citibank and Wells Fargo while others are made by insurance companies like AIG and Mass Mutual. WI students listed above. Wall Street insider to master covered call writing. The stocks and options prices vary and, as a result, clients may lose or profit from their original investment. Stock illustrations posted on TheWealthlyInvestor. However, in order to do this, acquiring the right education is vital. Rather than investing in Mutual Funds or buying and holding stocks hoping for an increase in value, why not dedicate a portion of your trading account to covered call writing every month? Yes, you can be a wealthy investor if you get started right now.

method Each day, billions of dollars are exchanged on Wall Street. The truth is that any investor with an online trading account can earn guaranteed income each month selling covered call options. DISCLAIMER: Stocks and options trading involves risk and is not suitable for every investor. Most investors need more monthly residual income from their stock market portfolios. Expiration cycle: The months in which options are going to expire. This is a huge subject area beyond the scope of covered calls; but it is invariably a mistake to use covered call writing as a primary method for picking stocks.

Warren Buffett and Benjamin Graham. These examples use calls that are above the purchase price of the stock. Assume that you have two stocks you are considering for your portfolio. The premium collected each time is tracked and when you have recovered the difference between the entry point and the current stock price you can change the break even point of the position giving you a different and earlier decision point for exiting the position without a loss of money. The short call is exercised. However, the premium levels are quite different.

Options are intangible contracts that provide rights to their owners. Huntington Asset Advisors wants to convert one of its mutual funds to an ETF. As long as the stock did not get away from you completely, the recovery by call method is to write covered calls repeatedly, usually for low premium levels. Preferred stocks can augment income strategies with priority access to dividends, but expose investors to interest rate and credit risk. None of these terms can be changed. It may also make sense to take profits when you have a substantial net loss of money in another transaction, so that losses and profits are offset in the same tax year. You also need to make sure you understand the transaction.

Covered call writers receive the premium and earn dividends as long as they own the stock. Table 3 shows the math for calculating the annualized yield based on comparisons between the option premium and current value of the stock for each of the options. The American Association of Individual Investors is an independent, nonprofit corporation formed for the purpose of assisting individuals in becoming effective managers of their own assets through programs of education, information and research. The CAT 60 July call offers comparatively more upside. All of these are above the purchase price for each of the stocks. Time value is a big problem for call buyers. Movement in the stock, changes in markets, and the timing between entry date and expiration make actual returns less certain. It becomes a long term buy and hold for you.

You close the position at a profit or to limit a loss of money. When comparing the income from covered calls, remember that dividends represent part of the overall return. Uncovered call: An option contract sold by an investor who does not own 100 shares of the underlying security. Second, the decline in time value is an advantage to you as a seller. The time to expiration impacts value because the longer the period to expiration, the greater the probability that the stock will reach and move beyond the exercise price. The rate of decline accelerates as expiration approaches, making buying options a difficult way to profit consistently.

For covered calls, you live with the lost opportunity risk or the sacrifice of potential profits you could earn by just owning stock when the price rises dramatically. Being alert and paying attention to the definitions can expose such tricks. The short call is rolled forward. If exercised, the market risk is eliminated because shares are available to be called away. Writing covered calls on a stock whose price has declined below your original purchase price is not recommended. Avoid writing covered calls with strikes below your cost. Whatever the reason the stock price dips, maybe not enough to get stopped out but below your entry point. The stock involved in every call trade is the underlying security. The primary argument against the covered call is that if the stock price rises above the strike price, profits on the stock are limited to the price specified in the contract.

However, this does not mean that writing a series of similar calls is going to produce that rate of return over the coming year. Call buyers take considerable risk. If the stock price has risen, you can also close a short call to limit losses. For some investors, this is an unacceptable risk; for others, it is gladly accepted given the potential extra returns from writing covered calls. As time value declines, a short call can be closed, creating a profit. Be willing to accept exercise. This difference in dividend should also affect the decision to use one stock over the other. Make sure you can accept lost opportunity risk. In the example above, the yields on Caterpillar are vastly higher than the yields on IBM.

The CAT calls are based on strikes between 60 and 65 expiring in the three closest expiration months. Never buy stock only to write covered calls; apply a sensible standard for picking companies whose stock you want to own. When you write, meaning sell, an option contract, you are short the contract. One huge problem with selling calls when you do not own 100 shares of the underlying security is the high risk involved. The Value and Momentum Trader. Time value: The portion of an option premium based on time to expiration; as expiration approaches, time value declines at an accelerated pace. Another aspect of covered calls that can work for you is recovery by call. Call: An option granting its owner the right, but not the obligation, to buy 100 shares of a specified stock, by or before a specific date, and at a specific fixed price. If a covered call is exercised, it should yield a capital profit and not a capital loss of money.

This creates the yield earned if the position were kept open exactly one full year. Exercise means you lose the potential for higher capital gains in the stock. In exchange for this income, there is a risk of lost opportunity. So the decision to use one company or the other for writing covered calls is a matter of matching the market risk of the stock to the risk tolerance of the individual investor. This is a logical choice when the loss of money on the short call is lower than the appreciation in the underlying stock. As the expiration date nears, time value decreases because there are fewer days during which the contract can be exercised before it expires. You cover this area extremely well. Evaluate covered call writing like any other option method: Be aware of the risks.

Covered calls should be written only on shares of companies you would prefer to keep in your portfolio. And it makes sense to sell when a sector is cyclically moving out of favor or when another company in the same sector has greater growth potential. Two stocks are used in the following examples: IBM IBM and Caterpillar CAT. For all of the billiards players out there, think of it as using a little English to improve your leave. This means CAT is a more volatile stock, and thus includes higher market risks than IBM. Exposure time is about 23 days. Get full access to AAII.

Assuming you would have picked Caterpillar as a purchase choice, the next step is to compare available options. In the case of exercise, your 100 shares are called away and your net profits include capital gains, the option premium and dividends. How about tax consequences? In both cases, you are happy to hold these stocks for the long term but, given the right premium levels for covered calls, you are also happy to risk having shares called away. What are the transaction costs for trading? Consult a tax professional about how a covered call method will impact your tax situation. Covered call: A method of selling one call per 100 shares owned of the underlying security. Not every investor holding 100 shares of stock should write covered calls. Maybe you bought the peak, maybe the market reverses, maybe the industry leader misses earnings and the sector takes a hit.

IRS Publication 550 discusses tax issues involving options. Pick a strike higher than the price you paid for the stock. Expiration date: The date on which an option expires and becomes worthless. Table 1 shows the math. You can avoid or delay exercising with a forward roll, a transaction in which you close one call and replace it with another that expires later. However, annualized yield in options analysis is valuable for making accurate comparisons between companies. With these risks in mind, if you want to write covered calls, you need to make sure you are willing to accept the premium in exchange for the potential of losing a large capital profit. If the stock price rises, the market risk is simply too great.

Among the dozens of possible strategies, covered call writing is especially popular for its potential to generate extra income for a portfolio. Underlying security: The stock or other security the option contract is written on, which cannot be exchanged or replaced. Comparing premium income on an annualized basis as well as dividend yield creates valid comparisons in picking a covered call. So, you must be willing to lose the occasional big profit in a stock in exchange for the income from covered call writing. With that said things go badly despite proper due diligence and the stock price drops below your entry point. Calls are quite cheap when compared to stocks; and the trading costs involved are quite low. Finally, you need to know in advance that having stock called away at the strike is an acceptable outcome. First, when you sell an option, you receive the premium instead of paying it. The popularity of options trading has grown in recent years.

This can happen at any time, but is most common on the last trading day of the expiration month. Member questions and comments on recent AAII Journal articles. Companies can use financial metrics to mislead investors. The first rule for covered call writing: Pick the company as a first step, based on your investment standards and risk tolerance. Does it make more sense to just sell the stock? Include dividends in the comparison. Select the stock as a first step. Strike price: The price per share at which 100 shares of stock can be bought or sold when an option is exercised.

You need to be happy selling 100 shares at the strike price. The rationale is that the higher yield will produce more relative income. For example, a CAT July 60 call shows annualized yield of 61. Certainly if you continue to hold your belief in the security one could stay in the position. The call option expires worthless. ETFs is a good idea in all but a strong bull market. The IBM calls available as of the June 30 close are based on a limited range of strikes between 125 and 135 expiring in the three closest expiration months.

Exercise: Using an option to trade in the underlying security. In this situation, you need to wait out the market until the value of the stock rises above your original cost basis. Your broker will have a table showing contracts for various months. Annualized returns should not be used as a yardstick to judge the value of all covered call writing. Say you picked a stock because you liked the hypothesis, the financials look good. Selling options is a more profitable approach, for two reasons. In some cases, you are better off selling shares and taking profits. The profit from selling calls with strikes above the price you originally paid for the stock will not be large enough to offset your loss of money in the stock itself. Premium: The current value of an option; the amount a buyer has to pay to acquire an option, or the amount a seller receives.

The covered call fixes your sales price at the strike in exchange for the call premium you receive. August 2010 AAII Journal. When you sell a covered call, you are granting the right to someone else to call away your stock. ITM call is also a way to get a bonus when you want to sell a stock if you are willing to accept the risk of holding on to the stock for a while. It is one of the most conservative options strategies. To annualize, calculate the yield by dividing the option premium by the current stock price. The second type of option, the put, gives you the right to sell. The forward roll can unintentionally turn a qualified covered call into an unqualified covered call.