Why I Like To Write Covered Calls
There is one method that I tend to use a lot, for a easy to remember reason; it can be an extremely powerful way to increase your returns in the stock market. The investment strategy is simply covered call writing and it is a pretty interesting way of making some extra money.
First let us look at the question, what actually happens when you start selling covered calls? With this strategy you get money up front but also become obligated to sell the stock at a specific price on or before a given date in time. There is a chance you will not have to sell the stock, but there is always a risk of being forced to sell it early.
Let us first look at an example you own a stock which is trading at $83 and sell the $85 covered call on it which makes you $5. You make the $5 as soon as you enter the position, however you will be forced to sell the stock at $85 if you are actually called out of it before the option expires.
So if the stock sours up to $100 you will be forced to sell it at $85 missing out on a huge majority of that appreciation. This would be the risk you take, by selling covered calls you are risking missing some great opportunity if the security does indeed make a nice gain in a short amount of time.
In fact by selling a covered call you risk an unlimited amount in potential profit because there is no set limit on how high a stock can go in the very near future.
With that in mind, why do this? Well, for one if you do not think the stock will make a large upward move in the next few weeks it could be a great way to get some extra profits. It could also be very helpful to to ease the pain if your stock crashes.
It is even a great way to get out of the security. If you are happy selling it at $85 and want to make a little extra cash before you exit out you can chose to sell the $80 call option for $8. You would be called out at $80 if the stock continued to stay above it, but you would have also made $8 on the call making you more money than if you had simply decided to sell the stock. But by doing this you are taking on the risk that it will in fact stay above $80 before the option expires, if it comes down below $80 you will most likely not be called out of the position.
This is most likely the best method of generating an income off of the stock you own. Many calls will expire within a month or two, this means you have the potential to sell up to 12 calls on your stock every year. That gives it an extremely powerful potential, especially if you combine selling covered calls with great dividend paying stocks that have great fundamentals.
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