A couple of years ago, my across the street neighbor bought another house on our street. He pays to have the grass cut, he keeps the utilities on, and the property appreciates; but that is it. For money-minded people like you and me, that seems crazy. He could easily be renting the house and earning steady, additional monthly income.
But what if I told you that you might be doing the same thing with your stock right now? Yep. Right now, millions of people are just sitting on stock in an account when they could be using it to create monthly 'rental' income using this one brilliant strategy: the Covered Call.
A call option gives the buyer the right but not the obligation to purchase 100 shares of a stock at a specific price on or before a particular date.
A call is considered 'covered' when the seller of the call option owns the underlying security. To use this strategy, you must own at least 100 shares of the stock you consider writing a call on.
Do any of these possibilities sound exciting to you?
These are just a few of the reasons why we love the covered call strategy. The Covered Call Strategy is a compound strategy. It has two parts: buying a stock and selling a call. If you already own 100 shares of the underlying stock, you can skip the first step.
The buyer of the call pays a premium for the right to buy the stock at the strike price. As the seller, you receive the premium in exchange for giving up some of the potential upsides of the stock price. If the option expires worthless, the seller still keeps the premium. Can you see the potential yet?
Your Step-by-Step Guide to Optimizing Covered Calls Results:
When choosing stocks for covered calls look for:
Here are a few things to avoid:
Do your general analysis as you would on any stock you were considering. Check support and resistance, moving averages, Stochastic, etc. Determine which direction the stock is trending. You might even want to start a watchlist! A great time to sell a covered call is at a resistance point with Stochastics turning down from overbought.
There are three methods to exit the Covered Call trade. No matter what happens, you can "cover your backside." Yes, that pun fully intended.
Method 1: If the underlying security stays out of the money, you keep the premium and let the option expire worthlessly. This method is preferred.
Method 2: Buy the option you sold back for less. Assuming time decay decreases the option's value, place an order to buy back the option at a reduced price. You then keep the stock and could sell another month's call at a higher strike price if you want.
Method 3: If the underlying stock price increases to or above the call strike price, you may either buy to close your option at the current market price and keep the stock or hold the trade and get "called out," which will require you to sell your stock at the agreed price. You can then repurchase the stock if it fits your plan.
As with anything, The Covered Call Strategy does have a few potential downsides, especially if you are growing a smaller account right now. The Covered Call Strategy requires more capital to execute than a typical long trade, and you must have at least 100 shares of the chosen stock in your trading account.
There is also the risk that the stock value will go down during the trade. However, this is a risk of owning any stock in the first place, whether you place a covered call or not.
Finally, there is the risk of unrealized gains. If the stock suddenly skyrockets while your covered call is open, you are still obligated to sell shares at the agreed price, even if that price is well below the current value. In this instance, you do not actually lose money. You lose the potential you had to sell the stock at a higher price.
There are two simple risk management rules you should always live by:
There are various ways to trade and after reading today’s blog we hope you would take a look at the Covered Call strategy. It is a fantastic way to generate repeatable cash flow and accessible to new options traders like myself. Join us next Thursday where we take a look at The Top 5 Favorite Candlestick Patterns.