Featured Post

Strategic Use of Credit Cards

I have have several credit cards and use them regularly.  Here are my do's and don'ts of using credit cards. Do's Use the credit...

Monday, November 22, 2010

Using Covered Calls

When the stock market is volatile, I like to sell covered calls as part of my trading strategy. For reference, selling a call obligates me to sell the underlying stock at a specific (strike) price. The buyer of the call purchases the right to buy the underlying security at a specific (strike) price. When a call is covered, the seller owns the underlying stock.

Covered calls provide me the following benefits:


  • A premium over the sale price. For example, if a stock is at $55, I can sell a $60 call for a $1 premium. If the stock is at $60 or higher at the call expiration date, I will receive $60 for the stock. Total sales price equals $60 strike price plus $1 premium or $61.
  • Earnings during a sideways trend. Using the same example, if the stock is under $60 on the expiration date, I keep the stock and the $1 premium for the call. Thus, I earned $1 while waiting for the stock to reach $60.
  • Insurance against a decline. For example, if a stock is at $55, I can sell a $45 call for $10.50. If the stock closes above $45, the totals sales price will be $55.50 ($45 strike price plus $10.50 call premium). If the stock falls below $45, I keep the stock and the $10.50 premium.
  • To get these benefits, there is an opportunity cost for using covered calls. I forgo any gains above the strike price since I am obligated to sell at the strike price. For example, if I sell a $60 call and the stock advances to $80, I am still obligated to sell at $60 and, therefore, do not get the $20 gain above $60.

    Hence, I prefer to use covered calls at short term highs when a stock is in a sideways trading channel. Thus, when the stock pulls back, I keep the call premium, wait for the stock to rally, and start the cycle again.

    For more on Strategies and Plans, check back every Monday for a new segment.

    This is not financial or investing advice. Please consult a professional advisor.


    Copyright © 2010 Achievement Catalyst, LLC

    No comments: