Writing covered call trading options against stock you already own is a great way to increase your return on investment.
Writing covered calls is an investment strategy for options trading that can super-charge your overall return on investment. This simple strategy is very conservative and actually reduces risk while providing additional income.
The main benefits of writing covered calls are:
1. Create monthly income.
2. Increase your return.
3. Reduce your risk.
These are three great reasons your plan should include covered call trading options.
The practice of writing covered call options involves buying a security (stock, commodity, forex future, etc.) and immediately selling a call option, on a share for share basis, against the underlying security. The premium received for selling the call is considered income by the seller of the call (also known as the call writer).
Covered Call Writing Example
Assume that it is November 15th, and a stock investor buys 100 shares of XYZ at $29 a share. His total investment is $2900. The investor immediately sells an XYZ DEC 30 Call for 2.00.
This option gives the call buyer the right to buy 100 shares of XYZ Stock from the investor at $30 a share any time before December expiration. For this right, the option buyer pays the stock investor a $200 premium. The investor gets to keep this premium, thus creating income, no matter what happens to the stock.
What happens if the stock goes up?
Let's say XYZ goes up to 35 on good news. The call buyer exercises his option on December 15, forcing the call writer to sell him his stock at 30 (he's been assigned or called out). He bought the stock at 29 and receives $100 profit from the increase to 30. He also gets to keep the $200 premium. The total profit on his $2900 investment is $300. The R
eturn on Investment is 10.3% ($300/$2900). The total time in this position was 1 month.
The investor has received his original investment, plus a profit on the stock price increase, plus the premium. He now has $300 more to invest in a new position for the following month.
What happens if the stock goes down?
This time, let's say XYZ goes down to 25. The call buyer does not exercise his option to buy the stock at 30. The option is uncalled and expires worthless. The call writer gets to keep the $200 premium and keep the stock. Even though the stock price fell, he still makes income of $200 on his $2900 investment.
The Return on Investment is 6.8% ($200/$2900). The total time in this position was just over 1 month.
The investor is now free to write another call for the following month, receiving additional premium or income.
Covered call writers often hold onto stocks after a decrease and continue to generate additional income by writing more calls. They continue this strategy until the stock returns to a price where they can sell the stock at a gain.
Tired of watching the stock in your portfolio move up, down and sideways?
Write covered calls against stocks you already own to generate monthly income. Manage your positions carefully so you don't get called out of stock you want to keep. New Insights on Covered Call Writing, by Richard Lehman and Lawrence McMillan, is a great book that will teach you how to do this.
For even better results, try trading options in ira accounts. You will want to speak with your accountant about tax considerations. Options trading rules are quite complex, but deferring your taxes will obviously allow your winnings to compound even faster.
Steve Rosenbaum is a former Chicago Mercantile Exchange employee who brings professional tools and strategies to the home investor. Visit http://www.options-trading-resources.com/Artic0001 for stock option and trading information for beginning traders and pros alike.
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