Covered Calls For Dummies
Most investors do not understand how to generate cash flow from their stock positions. Covered calls can be used to hedge your stock positions. My stock advisory newsletter first introduced to me the strategy of covered calls. I was shocked to discover that even major IRA accounts ran by brokerage firms allow you to write covered calls because of its relative safety to other option strategies.
The strategy is very similar to selling an option on a piece of real estate. For example, I'll give you $10,000 now, if you allow me to buy your property 6 months from now at a set price. If I choose not to exercise my option, you keep the money and we go our separate ways.
Ok so now let us go in more detail. I buy 1000 shares of CDE at $10 and the stock goes to $11 a few weeks later. I can generate cash flow in my position by selling someone the option to buy the stock from me 6 months from now at $12.50. For that option, the buyer is willing to give me $0.50 per share or $500 right now.
The $500 is immediately deposited into my brokerage account, but an option position also shows up on my statement. I can not sell the stock prior to 6 months unless I buy back the option in the open market. The option price can fluctuate from day to day, therefore, I typically hold my stocks until expiration.
Six months from now, two things can happen. One, the stock goes above $12.50 and the person "calls" me out of the position, which I am more than happy to do since I bought it at ten. Second, the stock has declined below $12.50 and the option holder is holding on to a worthless option. The option holder would not "call" the stock from me at $12.5 when he or she might be able to buy it in the open market at $11.50.
I then start the process all over again and write the calls again.
So let me back up. What exactly did I do here? First, I hedged my position by 5% or $500. Second, I set a strict target price that I was willing to let the shares go for, $12.50. Finally, I created immediate cash flow that I could use for my daughter's birthday or reinvest.
This strategy has made me very happy in bear markets because most options expire worthless and I get to keep my stock and what the option buyer originally paid me for the option!
A good friend of mine is a computer programmer. He also shares a passion for covered call writing and has written a program that is in beta testing. I am his BETA Dummy. So far, the program has saved me countless hours of research and has narrowed my focus to a short list of 5-10 natural resource stocks to add to my portfolio quarterly. In future articles, I'll discuss some of my picks and income generated from the covered call strategy, plus provide a link to the option software.
But remember, any option strategy involves more risk than just buying a stock so always consult with a licensed financial adviser first. - 23210
The strategy is very similar to selling an option on a piece of real estate. For example, I'll give you $10,000 now, if you allow me to buy your property 6 months from now at a set price. If I choose not to exercise my option, you keep the money and we go our separate ways.
Ok so now let us go in more detail. I buy 1000 shares of CDE at $10 and the stock goes to $11 a few weeks later. I can generate cash flow in my position by selling someone the option to buy the stock from me 6 months from now at $12.50. For that option, the buyer is willing to give me $0.50 per share or $500 right now.
The $500 is immediately deposited into my brokerage account, but an option position also shows up on my statement. I can not sell the stock prior to 6 months unless I buy back the option in the open market. The option price can fluctuate from day to day, therefore, I typically hold my stocks until expiration.
Six months from now, two things can happen. One, the stock goes above $12.50 and the person "calls" me out of the position, which I am more than happy to do since I bought it at ten. Second, the stock has declined below $12.50 and the option holder is holding on to a worthless option. The option holder would not "call" the stock from me at $12.5 when he or she might be able to buy it in the open market at $11.50.
I then start the process all over again and write the calls again.
So let me back up. What exactly did I do here? First, I hedged my position by 5% or $500. Second, I set a strict target price that I was willing to let the shares go for, $12.50. Finally, I created immediate cash flow that I could use for my daughter's birthday or reinvest.
This strategy has made me very happy in bear markets because most options expire worthless and I get to keep my stock and what the option buyer originally paid me for the option!
A good friend of mine is a computer programmer. He also shares a passion for covered call writing and has written a program that is in beta testing. I am his BETA Dummy. So far, the program has saved me countless hours of research and has narrowed my focus to a short list of 5-10 natural resource stocks to add to my portfolio quarterly. In future articles, I'll discuss some of my picks and income generated from the covered call strategy, plus provide a link to the option software.
But remember, any option strategy involves more risk than just buying a stock so always consult with a licensed financial adviser first. - 23210
About the Author:
Do not buy any stock trading education materials until you see Lance Jepsen's free stock market blog at how to invest in stock market, and learning the stock market
posted by X - Men @ 3:34 AM
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