Covered Calls

The covered calls strategy provides numerous ways to make money. They can be used to pay yourself a monthly dividend by selling call options on stock that you own. When you sell a call option in a covered call, you agree to delivery the stock at the strike price for until the call option expires. The covered calls strategy works best if the underlying stock is rising slowly. Under this condition, the call option used in the covered calls will have a significant premium. By collecting this premium, you can also give yourself some protection in a declining market. How? Use it to minimize losses by offsetting your stock's devaluation with premium income. Writing covered calls (selling call options on stock you own) can significantly increase the yield of your stock portfolio.

Covered calls are usually written using short-term call options so that time decay works in your favor. The term of the call option should be less than a month so that you can repeat the process monthly. By choosing the call strike price carefully, you can write a covered call every month on any stock you plan to hold over the long term.

What stocks are the best to write covered calls on? Since the profit is mainly from call option premium, the options should be expensive. Look for stocks with options trading at historic highs in implied volatility. These options will be expensive but have a high probability of decreasing rapidly as expiration approaches.

Covered calls should be written on 500 to 1000 shares of stock in order to keep commissions down. By using an online options broker, you can get the lowest commissions and possibly get good returns using a smaller number of options in the covered calls.

Another technique to maximize return is writing covered calls on stock priced between $10 and $30 per share. This price range will allow higher call premiums relative to stock price. Also, the call premiums will decay faster as the option approaches expiration.

What is the risk in trading covered calls? If you want to hold your stock for the long term, writing covered calls puts this at risk since your stock can be called away. By choosing strike price plus option premium above your basis in the stock, you will always profit if the stock is called away. Writing covered calls does not eliminate downside risk. However, each time you write a covered call the basis in your stock decreases by the amount of the call premium.

Covered calls can also be written on stock held in an IRA. This allows you to generate significantly higher returns tax free in your retirement account. This fact alone should make you want to learn about covered calls.