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The Ultimate Guide to Writing Covered Calls
Covered calls are one of the most popular option strategies available. They can be an excellent way to generate monthly cash flow while reducing your risk investing in the stock market.
What is a Covered Call?
When you write (or sell) a covered call, you are selling the call buyer the right to purchase shares of stock that you own at an agreed-upon price (the strike price) within a specified time frame (the expiration date).
For example, if you owned a stock currently trading around $43 per share, you could sell a call option that expires next month and has a strike price of $45. Two things can happen:.
- If your stock stays below $45 before the call expires (next month), you keep both the stock and the option premium.
- If the stock rises above $45 before the call expires, the buyer exercises the call, buying the stock from you for $45 per share. You get the money from the sale of the stock and the premium, but you no longer own the stock.
A buyer has the right to exercise their option up until the expiration date. If that happens — meaning the stock is called away — the shares are automatically delivered to the buyer. Options typically expire on the third Friday of every month.
Generally, when you buy a call option, you need the share price to move higher in order to make money and you also need it to happen within a relatively short time-frame. With each day that passes, options decay in value, which is bad for the buyer (but great for the seller). This makes call options a great choice for sellers looking to make a profit off stocks they already own.
Covered Calls Can Be a Powerful Tool for Cash Flow
Income investors can sell covered calls on a regular basis to collect premiums. Covered calls can also be used to exit an existing stock position or to achieve limited downside protection. While simpler than most option strategies, writing covered calls requires a basic understanding of options and how they work.
In this guide, we take you through everything you need to know to get started writing covered calls, as well as link you to resources and articles to develop your knowledge!
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