Professional investors have long known that stock options are a good source of income. They are wasting assets and so the buyers (usually non-professional investors) lose money as time passes and the options lose value. In the last decade or so, however, non-professional investors have been studying how to trade options in ever bigger numbers. Calls and puts are the instruments of choice, but we're going to talk about call options in this article.
Call options give the right for the buyer (holder) of the option to purchase shares for a certain price on or before a certain date. If you are the buyer then you give money today so that you have the right to exercise your option and purchase the shares you want at a known price. You can set the strike price and expiration date to anything you want (but lower strikes or farther out expiration dates will increase the price of the option). As an example, if you buy a "August 18 Ford call" then you have the right to buy 100 shares of Ford stock for $18/share at any time between today and late August (options always expire on the 3rd Friday of the month).
If you buy a call option and the stock rises before expiration then chances are you will have some profits. But if the stock only goes up a little then you may have a loss; depending on how much you paid for the option in the beginning. Because of this phenomenon, many investors have chosen instead to sell call options rather than buy them. They are taking advantage of the fact that options lose value as time passes. The risk is that the underlying stock shoots way up before expiration. In order to counter that risk, the investor who sold the call option would buy the stock at the same time. That way, if he is called upon to deliver shares after they have run up in value, he already has them. This is known as a "covered call" investment.
Here's an example covered call trade. Pretend you own 100 shares of BAC that you paid $14.50 for. You sell an option that expires three months from now with a strike price of 15 for $1. That means you will receive $100 today in exchange for giving up your stock at a price of 15 at any point in the next three months (up to the holder of the option to decide if and when he wants to do that). So, if BAC shoots up to $16 you will have to sell your stock for $15 to the person who bought your option in the beginning. But remember, he paid you $1 at that time, so you really sold your stock for $15 + $1 = $16.
Implementing a covered call strategy is not hard. Ideally you will own 100 shares or more of several companies so that you can get some diversification (never invest a big percent of your assets into a single investment). Because there are over 150K combinations of strike price, stock, and expiration date, it helps to have a covered call scanner to sort through the choices. There are many web sites on the Internet that will help you study covered calls. Many investors feel that if you own stocks or ETFs and you're not writing covered calls each month then you're just leaving money on the table.
Call options give the right for the buyer (holder) of the option to purchase shares for a certain price on or before a certain date. If you are the buyer then you give money today so that you have the right to exercise your option and purchase the shares you want at a known price. You can set the strike price and expiration date to anything you want (but lower strikes or farther out expiration dates will increase the price of the option). As an example, if you buy a "August 18 Ford call" then you have the right to buy 100 shares of Ford stock for $18/share at any time between today and late August (options always expire on the 3rd Friday of the month).
If you buy a call option and the stock rises before expiration then chances are you will have some profits. But if the stock only goes up a little then you may have a loss; depending on how much you paid for the option in the beginning. Because of this phenomenon, many investors have chosen instead to sell call options rather than buy them. They are taking advantage of the fact that options lose value as time passes. The risk is that the underlying stock shoots way up before expiration. In order to counter that risk, the investor who sold the call option would buy the stock at the same time. That way, if he is called upon to deliver shares after they have run up in value, he already has them. This is known as a "covered call" investment.
Here's an example covered call trade. Pretend you own 100 shares of BAC that you paid $14.50 for. You sell an option that expires three months from now with a strike price of 15 for $1. That means you will receive $100 today in exchange for giving up your stock at a price of 15 at any point in the next three months (up to the holder of the option to decide if and when he wants to do that). So, if BAC shoots up to $16 you will have to sell your stock for $15 to the person who bought your option in the beginning. But remember, he paid you $1 at that time, so you really sold your stock for $15 + $1 = $16.
Implementing a covered call strategy is not hard. Ideally you will own 100 shares or more of several companies so that you can get some diversification (never invest a big percent of your assets into a single investment). Because there are over 150K combinations of strike price, stock, and expiration date, it helps to have a covered call scanner to sort through the choices. There are many web sites on the Internet that will help you study covered calls. Many investors feel that if you own stocks or ETFs and you're not writing covered calls each month then you're just leaving money on the table.
About the Author:
Born To Sell's web site offers detailed information about covered calls. Born To Sells web site is known for covered call strategies.
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