Just because the stock market is down--doesn't mean you can't make money in it. There are possibilities. In this article we will explore some.
Things You'll Need
- Probably an experienced stockbroker
- Round lots (100 share blocs) of stock that have market options on them
One of the best things you can do when the chips are down in the market is to start writing covered calls to generate yourself some cash income. It won't allow you to totally recoup your losses, but it will give you some padding in your portfolio. When you write a covered call, you give the call buyer the right to purchase the stock that you already own at a preset price, known as the call price--a price that is always above the current market price.
The call buyer pays you a premium for the right to buy the stock at the call price. The call buyer does this because he or she thinks that the price of the stock will rise, whereas you will always choose a price that you think the stock will not reach before the option expires. But even conservative covered call writing can generate you hundreds or even thousands of dollars in premiums each year.
Remember, the farther away from the market price you are, the lower your risk--and the premium that you will be paid. The downside is that if your stock rises to the strike price--then you will be called out--and will have to sell the stock to the call buyer at that strike price--even if the market price has gone much higher.
Also keep in mind that you can only write covered calls on round lots of stock that you already own. But if the price of the stock begins to approach your strike price--you can close out your position and rewrite your calls at a higher strike price.
Tips & Warnings
- If the information in this article is confusing, consult your broker or investment advisor. Covered call writing is an excellent way to generate current income in a down market, but this is probably not something that you should do on your own unless you are an experienced trader. A competent stockbroker or money manager should be used for this sort of thing if you are a beginner.
- Although writing covered calls is by nature a conservative option trading strategy, it does involve the risk that your stock will be called out and you will have to sell it at a price below the current market price. The sale will also generate a reportable capital gain or loss, unless it is done inside an IRA.