There is little doubt that you have heard lots of information touting the unbelievable earnings possibilities of buying and selling stock options. This may certainly be true, but it only occurs for a small number of options traders as the majority of options traders lose money.
The fact of the matter is that options are usually high risk financial tools. There is money to be made in conservative options trading if you enact the best strategy for your investment objectives.
Writing covered calls is, simply, one of the least risky strategies for utilizing options, with the greatest possibility of consistently realizing a profit.
What Are Options?
An option is the ability to make a specific type of financial transaction. A call is a specific type of option that allows the buyer of the call option the opportunity to buy a certain asset, such as a stock, at a specified price.
An investor can buy a call option on a security that allows you to purchase the asset at a set price per share. A trader then has the option to buy the security at the agreed upon price per share for as long as the option lasts.
Where there is a purchaser for the call option, there needs to be a seller as well, and in this case that would be you. A call – like other types of options – has a limited time frame. This time frame can vary from a few days to a few years.
Writing A Call
Another was of saying selling a call is “writing a call”. When you sell (write) calls, you have to also be ready to sell the security to someone at the price the option you wrote specifies. You are writing covered calls if you write calls against securities that you own already.
It is extremely risky to write calls against stock you don’t already own. Only the bravest (or dumbest) of investors use this strategy, and it is referred to as writing uncovered calls. In this scenario, you would be required to purchase the stock that you don’t own already, and then sell it to the investor who purchased your call.
You ideally want to achieve the best proportion between gaining the maximum price for the calls that you sell, and simultaneously having the lowest possibility of being required to sell your equity at the price outlined in the option that you wrote.
You ideally would like the option you sold, and got paid for, to expire valueless to the buyer. This can be arranged by having the calls you sell against your security set a purchase price – or strike price – that is higher than what the stock is selling for currently on the exchange.
The nearer the strike price of the option is to the present cost of the security, the more money you will make selling the option. Conversely, the further away the strike price is from the selling price, the less money you will make.
So, why would anyone buy the right to purchase an asset at a cost that is greater than what it now sells for?
The reason is that they believe that there is a possibility that the selling price of the security will rise by enough in the future, that purchasing the stock at the price specified by the option will be a good deal. Therefore, the seller hopes that the price of the stock does not go up, while the buyer of your option wants the price to rise.
Writing Covered Calls Allows You To Profit In Any Market
Writing covered calls is an excellent way to mitigate some of the volatility that all stocks go through at some time. When you are feeling disappointed by watching your securities steadily decline in worth, and if you have been wondering if you should take the loss, you should look into writing covered calls.
You will not have to be concerned about the buyer of your call utilizing it to purchase your stock when the stock price decreases. The money you take in for writing the calls will also partly counterbalance the decline in value of your stock. You would then come out on top in the long run when the price of the stock rises.
Always seek the help of a financial adviser before attempting to write covered calls, or engage in options trading.