Selling a Regular Covered Call
This is a very popular options strategy, used to generate extra monthly income on stock you own.
You basically sell another investor a Call Option, which gives them the right, but not the obligation, to buy your stock, on a certain date, at a certain price, and for that they pay you a fee, called a premium.
Usually you pick a price, for which there is a very low probability, that the stock will hit it, with in the prescribed time period.
The goal is not to sell, but to generate monthly income from the Premium.
Example:
Apple is trading at 125$ USD, you sell the 150 dollar call, for 0.50 USD. Equity Options are sold in lots of 100 called Contracts. So you multiply 100 times 50 cents (0.50) and that equals 50.00 or 50 dollars, and that is how you collect $50.00 in Premium for the month.
Now that I have reviewed a regular covered call, I will discus a Poor Man’s Covered Call.
Poor Man’s Covered Call
You don’t have to own a stock to sell someone the right to buy it, but you need to control it, with an option to buy it. So if you buy a Call Option, giving you the right to buy a stock at 100 $ USD, you can turn around and sell someone else the right to buy it at 105$.
So instead of buying 100 shares of Apple for 100$ per share, at a cost of 10,000 dollars. You buy one Call contract, giving you the right, but not the obligation, to buy Apple for 100$ per share, until your contract expires. This will probably cost you 50$ versus 10,000 dollars. But it allows you to control 100 shares for 60 days. Now you can sell calls on this 100 shares, just like you owned them. If you can get more then 50 cents per share, say 55 cents, you get paid 55 dollars and 5 dollars is your profit.
This is how a “Poor Man” defined as someone who doesn’t have enough money to buy 100 shares of stock can still sell a covered call. So it’s sometimes called a “Synthetic Covered Call”.
This is one version. Another version involves buying the Call Option for 60 days, and selling Calls two months in a row, to increase the profit from a trade.
Options & Leverage
One reason that options are popular is because they don’t require a lot of capitol or money to get started trading, and because the change in stock price causes an exponentially larger change in the option price. The stock may cost 100$ while the option to control that same stock may only cost 2 dollars. A one dollar change in the stock price is only 1% of 100 dollars. While a one dollar change in the stock price represents a 50% change in a two dollar option. This is called Option Leverage.
When you combine low barrier to entry with the attractiveness of leverage, you have a very attractive financial vehicle. The Options exchange in America is larger in volume then any Stock Exchange in America, for this reason.
Knowledge is power, and power can become wealth. Keep learning my friends.
