There are many ways to go about the investment market, and the flood gates tend to open up when talking about covered calls.
The concept is relatively conservative, but when done right, it can prove to be profitable.
Exercising a strategy such as covered calls would require quite a bit of learning and using a tool like a free covered call screener to make the best of it.
A popular options strategy used for risk management and income generation, covered calls require you to hold the long position in an underlying asset, known as stocks, and sell a call option on the said asset.
Apart from stocks, covered calls are used for the trading of the options contract.
The strategy is often used by investors who think that the underlying asset will only experience a minor fluctuation in its prices or are looking to boost the income from their stock portfolio.
If you already own stocks or ETFS, you know that you can sell the security anytime at your convenience at the market price.
When you implement the covered call strategy, you sell this right to the option buyer in exchange for a premium. This sum can be determined with the help of a trustworthy free covered call screener.
The option buyer now has the right to purchase your shares on or before the option expiration date. Obviously, this will be at a predetermined price or the strike price.
An important point to note here is the expiration date. Each expiration date will have its own option chain listing the strike prices with puts and calls for each. Monthly options expire on the third Friday of each month. Many securities have weekly options as well, which expire every Friday.
Let’s get the hang of the strategy through an easy-to-understand example.
Now, you will be obligated to sell your 100 shares of Company A anytime prior to expiration at $105.
The option buyer will exercise the call option if your stock price increases to $110. In exchange for the $4 premium, you sell your shares for $105 even though the market price of the stock is $110. Although you missed out on the profit potential of about $105, you received the premium of $4.
Since the strike price exceeds the market price (it’s out-of-money), the buyer will not exercise the option. You keep your 100 shares and the $4 premium received when selling the covered call.
Just how the call option expired in the last scenario, it will do so here as well. The stock value has dropped by $10 per share. You still keep the $4 premium. This risk management feature of covered calls partially offsets the stock loss, you’re left with an overall loss of $6 per share.
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A covered call trade will require you to follow these basic steps.
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A trader must consider all options thoroughly before implementing the covered calls strategy.
Primarily, covered calls are used when you want to earn an income through premiums by selling off calls against a stock you already own.
If the stock stays below the strike price, you should collect the premium while maintaining your stock position. If the price at expiration ends above the strike price, you will be obligated to sell your shares, but you still keep the premium originally received when selling your covered call.
Once again, the strategy should be formulated after studying the market thoroughly or by using optionDash’s covered call stock screener to find income-producing trades.
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