writing covered call
best article about writing covered callWriting Covered Calls - An IntroductionSteven T. Ng | 13th September 2009Writing Covered Calls are a "moderate" investor's favourite strategy. It works particularly well when the stock in question doesn't move dramatically up or down, but rather just trends sideways. Basically, it works for stocks that are deemed too "boring" for option plays. For writing Covered Calls, we need to take a look at the opposite side of buying options, which is selling stock options . The term "writing" refers to the act of selling stock options. So when we write covered calls, we are actually selling a call option. To recap, buying a call option gives you the right, but not the obligation, to buy a stock at a specified price at a specified date. Conversely, if you sell a call option, you now have the obligation to sell the stock to the option buyer at the agreed upon price at the specified date. So a Call Writer is agreeing to the obligation to sell stock, while a Put Writer is agreeing to the obligation to buy stock. Scary isn't it? Who would want to enter a contract with such obligations? The good part is, when you sell an option, you receive the Premium of the option. Which means you instantly make money from a transaction. In that case, why doesn't everyone start selling options? Let's take a closer look at selling Call options. To recap: when you buy an option, you buy the option to Open a Position, and sell it later on to Close the Position. Similarly, when you Write options, you write the option to Open the Position, and you must Close the Position somehow, whether it's by letting the option expire worthless, or by buying the option back. In the case of selling Call options, remember that Call options are more In-The-Money the higher the stock price goes. So if you sell a Call option and the underlying stock price goes down below the option's strike price (meaning the option becomes Out-Of-The-Money), the option will expire worthless. You therefore don't need to do a thing, and can pocket the profit you earned by selling the option. However, the danger happens when the stock price keeps climbing. If it keeps going up, it will never become worthless, and come expiration day, someone is going to exercise the option and buy the stock from you. You have been Called Out. The problem is, you don't own the stock! You would need to buy the stock at the current market price (which has gone up), and sell the stock to the option buyer at the previously agreed strike price, which would have been lower. This would cost you a lot! In order to lessen that risk, what we can do is to actually buy the underlying stock the same time we sell the option. For example, if you want to sell 1 contract of ABC options, you would buy 100 shares of the ABC stock at the same time (remember that 1 option contract is equivalent to 100 underlying shares). By buying the shares, we eliminate the risk of having to buy the shares later at a higher price in case we get called out. This is called covering your call writing, ie. we just wrote a Covered Call. For a more specific example on writing covered calls with diagrams, please visit: Steven is the founder of the Option Trading Guide at , a website that provides information on trading stock options and technical analysis techniques. Tags: , , , , , , , , , |
Covered Call WritingKevin Matras explains how to implement a Covered Call option strategy. Stocks highlighted include APEI, GHL, PLCE, MYGN and WAB. |
Q&A on Covered Call Options - The Options Insider
A Sirius Investment Strategy - SiriusBuzz.com (blog)
Hysterical Optimists Crowd Transocean Call Trade - Forbes
|