Using Covered Calls

Since I am retired, I periodically do a rollover of my company stock from my retirement plan to my traditional IRA.  This allows me the additional option of using covered calls while trying sell some of my company stock.  A covered call enables me to get additional gains from the call premium and sell my stock at a higher price.  The main risk is the stock may fall signficantly, and the losses are greater than the premium received for the call.

A call is like a coupon; it gives the owner of the coupon a right to purchase an item at a specific price.   A coupon is usually free, but in the case of a call option, a buyer would purchase the call option from me.  

Here's an example of how I use covered calls.   Say my company stock is currently priced at $40.00 and I want to sell within the next six months at $45.00. Since the price is currently $40.00, no one will pay me $45.00 for my stock.  One approach is to wait until the price reaches $45.00 and sell the stock.  Another approach is to sell a $45.00 call option (coupon) for $1.00 that is good for six months.  I have chosen the second approach.

Here's the reason I chose the second approach.  In the first approach, I receive $45.00 when I sell the stock.  In the second approach, I receive $46.00 when I sell the stock for $45.00 because I received $1.00 for selling the call option.  If the stock doesn't reach $45.00 at the end of six months, then I still make $1.00 since I keep the money I make from selling the call option.  Then I can repeat process of selling a call option again.

The main risk is the stock falls significantly instead of rising slowly or staying the same.  If the stock falls to $35.00, the $10.00 decline is greater than the $1.00 I received for the call option.  Also, if the stock didn't have a covered call, I could have sold the stock at a price below $45.00 but above $35.00, and minimize my losses.   However, if I was planning to hold until $45.00, then I'm still $1.00 better off while waiting.

The other risk is the stock goes to $50.00 and I am obligated to sell the stock at $45.00 to a holder of the $45.00 call option (coupon).  This is lost profit, but it's not different than if the stock goes up to $50.00 after I sell at $45.00.

Since I believe the stock will get to $45.00, am willing to wait and am happy with that selling price, I have sold short term covered calls increase my gains when I eventually sell the stock.

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

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