Options Trading- Selling Covered Calls

This options strategy is one of the most-used methods and least risky. It can occur when you have atleast 100 shares of a company and believe that this company will not rise above a certain price in an allotted period of time. To sell a covered call means that you agree to sell 100 shares of a stock (1 contract) at an agreed upon strike price and expiration date. For this agreement, you are paid a premium by a buyer and must put forth your shares as collateral. If, by the time the expiration date of the contract hits, the share price is higher than the strike price, then your shares are called away and you keep the premium, in addition to the worth of your shares. However, if the share price is lower than your strike price at expiration, then you keep both your shares and the premium. This entire situation can be a win-win if you know how to do it.

For example, say you bought a 100 shares of a stock at $10 per share. You then think that the shares will drop in price, but you do not want to sell. You decide to sell a covered call at a strike price of $11. This option will expire at the end of the week, and you will be paid $50 for it. Assuming that you were right about the price drop of the shares, the week ends with the shares closing out at $9.60. Normally, you would be down $40 had you decided to hold and not incorporate options. However, since $9.60 is below your strike price of $11, you keep both your shares and the premium, and you are still profitable since your current cost basis is $9.50 per share ($1000 for the shares minus the $50 from the covered call). Now, assume that you were wron about the whole price drop scenario, and the stock rises to $11.20. At this point, you might think that you have lost out on opportunity, because you have been forced to sell your 100 shares for $1100 ($11.00 strike price) and are missing that extra $20 profit. However, since you still keep the $50 premium, you are actually making more money than you would have if you had just held the shares normally. This creates a remarkable situation. If you can predict the general direction of a stock and continue to sell covered calls, you can collect easy cash each week or month and lower the cost basis of your shares. Using this method is easy, relatively safe, and a long term strategy that will make you consistent gains.