Selling covered calls is a great way to earn some additional income from the stocks you already own.

It is also a tremendous way to mitigate risk and turbo charge your overall portfolio’s rate of return.

When discussing option trading systems, you are basically talking about one of five basic techniques. These include buying calls, selling calls (naked), selling calls (covered), buying puts, and selling puts.

Since we are only interested in methods that have been proven to work consistently by investors of all abilities, we will be focusing primarily on selling covered calls; which are widely believed to be the most conservative of the techniques mentioned above.

What are Covered Call Options?

Most investors, both beginners and advanced, are familiar with the mechanics behind buying and selling stocks. Writing covered calls is not much different from what you may already be doing. The primary difference is that you are selling someone the right, but not the obligation, to buy your stock (which you already own) at a certain price (known as the strike price) and on or before a certain date (known as the expiration date).

In exchange for granting someone the right to buy your stock, you will get paid a specified premium (cash in your pocket). Basically, you are renting your stock to some other investor (let’s just go ahead and call them what they are – a speculator). This premium is what makes the covered call strategy so powerful and, potentially, profitable. In a flat to slightly declining market, it is not unrealistic for an average investor to earn a premium of 5 to 10% per month.

What are the Benefits of Writing Covered Calls?

Many rational investors may wonder why they should get involved with such a seemingly difficult investing strategy when it is so easy to simply buy and sell stocks. The short answer is, well…. quite frankly, the CASH. Additionally, here are a few additional benefits derived from covered call writing:

• Investors can profit from normal fluctuations in the stock market. If your stock declines in value you can write calls against those positions effectively reducing your cost basis in that position. The premiums you receive bring down the overall price you paid for the stock making it easier to earn a profit.
• Premiums are placed into your account the second you sell the call. Investors that have larger portfolios can actually live on just the premiums they collect each month.
• If you are called out of a position, you can easily reinvest your proceeds in the same stock within a few minutes. You could also take a different direction and choose to invest elsewhere. The possibilities are endless.

Of course every investment involves some inherent risk. The covered call strategy is no different. Here are a few risks to consider before trying this strategy.

• After selling a call at a strike price, you are obligated to sell your stock at a certain price. If the price skyrockets 100% higher than your basis, you still must deliver the stock at the previously agreed upon price.
• Your underlying stock may decrease in value. When this happens, you can sell another call against this stock but more likely than not, you may either have to sell the call at a lower strike; which may increase your risk of selling the stock at a loss, or you may not get your desired rate of return. Having your stock decline significantly can seriously damage the value of your portfolio.
• Not all investors are suited to this strategy. There is something rather comforting about a typical buy and hold strategy. If the stock declines in value you can always hold it until it rebounds. This is not the case with options, since they are time sensitive investments.

 

Option trading systems can be the perfect match for some investors, while being a complete disaster for others. All investments involve risk yet selling covered calls may prove to be the least risky of all investment strategies.