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New Options Trading Course System
Covered Call Option Strategy
If an investor shorts a call contract and is long shares of the underlying stock, the person is considered covered on the option. This is a writing strategy.
Writing or selling covered calls generates premium income for the investor. The premium received lowers the break-even and creates a hedge on the stock position, should the stock go lower. If the option is exercised, the writer (seller) must deliver the stock at the strike price on the call. Since the options trader own the stock, the shares can be delivered out with no market risk on the option.
Example and Situation
An options investor buys 100 shares of TRE at $65. Six months later the trader notices the stock has not moved or moves very little in price. A strategy that could be used if this trend continues would be a covered call option sell on the stock owned.
Long 100 Shares of TRE at $65
Short 1 Aug TRE 70 Call for $200
Writing a covered call option will give the person income of $200. When options are sold, the writer gets the premium. This also lowers the break even for the investor to 63. If the option expires, the customer is fine with it. The point of this strategy is to take advantage of a stock's stability. As long as the stock remains near it's price, or at least below the strike price on the call option - the strategy is profitable.
However, if the stock falls below 63 - the investor can lose the entire investment beyond that down to zero. Since the stock was not protected beforehand anyway, that is not a big concern.
With writing these options, The gain on the stock is limited while the call option is in play (prior to expiration). If the stock rises to 70, the call will get exercised and the trader will only be able to make the 5 point difference between the stock price and the clall option strike price - plus the $200.
The best case in this type of strategy is to gain on the timing of events. Having the stock remain in a holding pattern while collecting the option premium is best. Once the option expires, the investor would hope for a big jump in the stock or the person could just do another call writing strategy again - if he feels the stock will remain steady.
Using covered calls with stocks can make investors money several times over, but the stock and it's trends need to be predictable.
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