Professional investors have long known that stock options are a good source of income. They are wasting assets and so the buyers (usually non-professional investors) lose money as time goes by and the options lose value. In the last decade or so, however, non-professional investors have been studying how to trade options in ever bigger numbers. Puts and calls are the weapons of choice, but we’re going to talk about call options in this article.
If you think a stock will go up in value, you could buy a call option. That would give you the right to exercise your call option at any point between today an the expiration. If you did exercise your right then you would pay the strike price per share for the stock the option was written on. You can set the strike price and expiration date to anything you like. For example, if you buy a “September 21 Cisco call” then you have the right to buy one hundred shares of Cisco stock for $21 per share at any point between today and the 3rd Friday in September (options always expire on the 3rd Friday).
The vast majority of options held until expiration expire out of the money. Because of this, most professionals will sell options instead of buying them (and most retail investors will buy options instead of selling them). The risk when selling call options, though, is that if the underlying stock rises above the strike price quickly then the seller could be forced to go into the open market and buy shares at the then current market price so that he can deliver them to the buyer of the call option, should the buyer decide to exercise. To protect against potentially unlimited losses, most sellers of call options will also be buyers of the underlying stock (in case they need to deliver it), thus creating a ‘covered call’ position.
Let’s look at an example covered call. Pretend you own 100 shares of Ford that you paid $17.50 for. You could sell a call option that expires in three months for a strike of $18 for $0.90. You will receive $90 today but you take on the obligation to sell your Ford at any time in the next 3 months for $18/share (if the buyer of your option so chooses). If Ford is above $18 on expiration day then you will receive $18/share for your stock. But consider that you received 90 cents at the beginning, so it’s really like you sold your stock for $18.90 (sum of the strike price plus the option premium). So you still made money, but if Ford goes up to $21 you didn’t make as much as you could have.
Implementing a covered call strategy is not difficult. You will want to own 100 shares or more of several different companies so that you can get some diversification (never invest a big percent of your assets into a single investment). Because there are over 150K combinations of stock, strike price, and expiration date, it helps to have a covered call scanner to sort through the choices. There are many web sites on the Internet that will help you learn about covered calls. Many professionals feel that if you own stocks or ETFs and you’re not writing covered calls each month then you’re just leaving money on the table.
Born To Sell’s web site is exclusively about covered calls trading. Click here to go to Born To Sell’s website on covered call options.