I like to show investors not only how to make money in the markets, but also how to use leverage to maximize their return on investment (ROI). Often it requires embracing new methods.
Here, I discuss a profitable weapon to add to your investing arsenal: the covered call. I compare the pros and cons of this strategy and when it’s the most appropriate.
I elaborate on all of these points, in my embedded “training video” below. Next issue of Power Profit Trades, I will provide a specific example of a covered call opportunity for you to act on.
The covered call can potentially generate extra income over and above the conventional buy-and-hold tactic – but only under the right circumstances. Let’s get started.
With this strategy, you own stock and you’re selling the right to buy your stock at a specific price on or before a specific expiration date.
To execute a covered call, you first have to own stock or buy stock. Your stock may or may not be bought. To give someone the right to buy your stock, you sell a call option. A call option is a contract that gives the buyer of it the right to buy stock at a certain price (strike price) on or before a certain date (expiration).
One options contract is the right to 100 shares of stock. For you to undertake a covered call strategy in your account on a stock you own, you must hold at least 100 shares of it. If you have 158 shares of stock you can only initiate one contract, because there are no contracts for 58 shares or .58 of a contract.
The term “covered” means you “own” the stock. When you sell the call option you must wait until someone in the marketplace exercises their right (the option) to buy your stock at the strike price or expiration.
“Called out” of your stock is the term for when your stock is bought away from you.
This would happen if the stock went high enough above the strike price that someone deems it better to execute the purchase of your stock at that lower strike price, versus the current market value of the stock.
Example: You sold a 50 Call against your 100 shares of stock and the stock goes to $57. Someone may think it is a better value for them to exercise their right and buy your stock at $50 instead of $57 per share, even if they paid $2 for the option right to do so. The $52 cost ($2 for the option + $50 for the stock = $52) versus market price of $57 still gives them a profit.
If you aren’t called out and expiration comes and goes, you get to KEEP the premium for which you sold the call option. In the above example, you would keep the $2 times 1 contract or 100 shares, equaling a profit to your account of $200.
The great thing about this is you get to keep that money, plus you get to keep your stock. You can look at the next month or further out and decide if you want to put your stock up for sale again and get paid to do it … again!
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