How to Manage Covered Calls

If you own common stocks, selling (or "writing") covered call options can be an excellent way to increase your returns, generate current income and provide protection in the event that the price of your stocks decline. When you sell a covered call, you're giving another investor the right, but not the obligation, to buy your stock at a predetermined price (the "strike price") on or before a specified date (the "expiration date"). For this right, the other investor will make a cash payment to you, known as the option "premium."

Things You'll Need

• Brokerage account with option agreement
• Minimum 100 shares of common stock
• Online or telephone quote access
• Calculator

Instructions

1. Review your portfolio and determine which of the stocks you own have options listed on them. Almost all large companies and many smaller companies have listed options available for you to sell. The best stocks for covered call writing are those whose prices are expected to remain relatively flat or even decline slightly in the short term. Determine which of your holdings meet this criteria and select a few possible candidates. You can also select a new stock that you plan to purchase and sell options on it as soon as the purchase is made.

2. Check the available strike prices and expiration dates for the options you wish to sell. You will find that the option premiums are highest for options with strike prices at or near the current selling price of the underlying stock. You can sell these options to realize the highest possible premium, or for added protection, you can sell an "in the money option," i.e., an option with a strike price below the current price of the stock. Alternatively, if you are expecting the stock price to rise, you can sell an option at a higher strike price. You will receive a lower premium for that kind of option, but you will still be able to benefit from appreciation in the price of the stock.

3. Determine the length of the option you wish to sell. Options are usually available with a variety of expiration dates, ranging from one month to several years. The longer the time until the expiration date, the higher the premium you will receive. However, you should remember that you will be obligated to continue to own the stock either until the option is exercised or until it expires.

4. Place your order to sell your covered calls with your broker. Since option prices change rapidly, it's a good idea to always place a limit order, specifying the minimum price you will accept for the options you wish to sell. Once you've placed your order, confirm that it has been executed at the price and in the amount that you specified.

5. Continue to monitor the prices of your stocks on a daily basis. If one or more appear to be declining rapidly, you can get out of your option contract by purchasing an option with an equivalent strike price and expiration date. Once you do this, you are no longer obligated to hold the underlying stock and can sell it at any time. If the expiration date arrives and your options have not been exercised, you can sell your stock at that time or write a new option for a later expiration date and receive another premium. In this way, it's possible to earn a good return on a stock even if its price doesn't move at all.

References

• Option Stategies: Covered Call
• Covered Call - Wikipedia
• Characteristics and Risks of Standardized Options