How to Sell Covered Calls

Selling covered calls is one of the best ways of guaranteeing a monthly income from your stocks regardless of what the market is doing. But what exactly is a covered call? A call is an option on a stock. The owner of a call has the right--but not the obligation--to buy the stock at a set price for a limited amount of time. If you own a stock, you can sell someone the right to buy that stock away from you at a set price. In exchange for that right, the person buying the call pays you a fee, known as a premium. Regardless of what happens to the price of the stock itself, you get to keep the premium and do with it whatever you wish.Many people claim that you can make your fortune selling covered calls--and to some extent they are right. As long as the calls you are selling are for stocks that are trading sideways or trending up in value, you can make a good return on your investment through selling covered calls.However, if the stock you are covering goes down sufficiently in value, you will still take a loss--although not as large of a loss as you would have taken had you not sold a covered call.

Difficulty: Easy

Instructions

Things You'll Need:

• Trading account with a stockbroker
• Shares of stock

1. Open a trading account with a stockbroker if you do not already have one. Make certain that your account allows you to sell covered calls (most do, but it is best to confirm).

2. Research and purchase a stock which you believe will remain at the same price or trend higher. (Covered calls can also be sold against stock which you have previously purchased.)

3. Look at the option prices (known as a "chain") for the stock you wish to write a call against. Your broker should provide up-to-the-minute options quotes. Choose a Strike Price that is higher than the current value of the stock and preferable higher than the amount you paid for your stock. For example, if you paid $10 per share for your stock you may wish to sell a $12.50 call. The further away from the current price of the stock your strike is, the less you will be able to sell it for.

4. Choose an expiration month. The further out in time you sell the more you will make--but the less often you will be able to sell options on your stock. Generally, 30 to 60 days in the future is a good amount of time to sell.For example, if today were January 1st and you paid $10 per share for your stock, you might wish to sell the February $12.50 call. You might also choose to sell the March $12.50 call for an even higher price.Choose a strike price that you will be happy to sell your stock at. If the market moves up and the price of your stock hits or exceeds the strike price, you could be forced to sell your stock at the strike price you have chosen.

5. Sell the call you have chosen. If you use a full-service broker simply tell your broker which call you wish to sell and your broker will handle all the details. If you use a discount broker you will need to sell the call yourself. Each broker has a different procedure for selling covered calls, but all of them make it easy. If you have any questions consult your broker's Help Desk.

6. Collect your premium. Within 72 hours (sometimes sooner) the premium you received for selling the call will clear to your account. This is your money and you may do with it whatever you wish.

Tips & Warnings

• Selling a covered call limits the amount of money you can make on the underlying stock. If you sell a $12.50 call on a $10 stock and the price of the stock shoots up to $15 you will be forced to sell your stock for $12.50--the strike price you sold. The advantage to you is that you get to keep the premium you received for selling the call plus you get $2.50 additional profit on the sale of your stock (12.50 - 10 = $2.50).
• If the value of your stock never reaches the strike price before the options expires, you keep your stock and you can write another covered call if you choose. You can continue writing covered calls on your stock as long as it is not purchased away from you.
• Learn as much as you can about options and the way they work in order to maximize your profits when selling covered calls.

Resources

• Learn about options trading from the Chicago Board of Exchange