Covered Call Secrets Revealed

A covered call is one of my favourite strategies, but that's probably not what you wanted to hear. A Covered Call is probably the most basic of Option Strategies, but it is also one of, if not, the safest strategies around.

The definition right out of a text book would read like this. "An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This is often employed when an investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium." This strategy is also known as a Buy Write, because you can first buy the underlying shares, then write a Covered Call right away on them.

The Covered Call is a great way to generate monthly income if you own some shares that you are not to sentimental towards. I say this because there is a chance that you will have to sell your shares at some stage if you get exercised. Say you already own 1000 XYZ shares that are currently trading at $50. If your view of the stock was neutral then you could write/sell a call contract at a strike price of $52. For selling this contract you could be paid a premium of $1.50 for each share. Now Options Contracts are in lots of 1000 (100 in the US), so you would receive $1500 for writing one contract. $1500 for one phone call is pretty good money in anyone's language.

Now the share price can do three things. If it goes up above the strike/exercise price then you will have to sell your shares at the agreed value of $52. So on top of the $1500 you made you will now receive an extra $2000. Not bad at all.

If the share price remains around the same value or below the strike price, then the option will expire worthless and you still have your $1500 (you'll always keep this), and you can write another call for the next month if you wish.

If the share price goes down, then you have what is called Downside Protection. The share price would have to fall by more than $1.50 for you to have a paper loss.

Simple stuff, but a very powerful strategy that the wealth use with their portfolios to generate massive monthly incomes for no more risk than holding shares. In the Australian market, you could expect to get a premium of 2.5-3.5% per month on certain stocks. Go to the US Market, and you are looking at between 3-7%. Remember, these figures are per month and if you have a substantial portfolio then you are looking at generating some substantial wealth here.