Writing Covered Calls For Income

Beyond dividends, and beyond selling at a profit, how else could you make money from owning stocks? What if you could make money from stocks that you already own, just by offering to sell them to someone else at a set price? You can–and that strategy is called “writing covered calls.”

How does this work? First, find a brokerage that allows you to write covered calls. To start with, you should already own (or buy) at least 100 shares of stock in a company you would still feel comfortable owning even if its value dipped. To approach this conservatively, utilize a stock whose price is relatively stable;  perhaps a dividend-paying stock. If you choose a stock with more volatility, the ride can get a bit wilder. Why 100 shares? That’s the minimum amount of shares of stock you need to own in order to write a covered call.

Next, fill out online forms with your brokerage. As you do this, you are initiating a contract. You agree to sell your stock at a price you specify in the contract, within a time frame you specify in the contract, to a buyer. You receive money, called a premium, in exchange for promising to sell your shares at a pre-determined price. Once you write the contract, or call, you earn the premium. Why would a buyer be interested in the call? Let’s assume the price of the stock goes up in the time frame of the call. The buyer is purchasing the right to buy your stock at what is now less than market value, and can exercise, or “call,” their option. What do you gain? The premium money. What do you lose? The chance to sell your stock at a higher market value.

Suppose your stock is “called”–the stock rises to the level you’ve pre-set in your contract, and the buyer of your call exercises their option to buy that stock at that pre-arranged price. The buyer will only do this if the pre-set price of your stock is less than that of market price. In other words, the market value of your stock has climbed past your pre-set price, in the time frame you’ve set, in your covered call contract. This written call is “in-the-money.” But what happens if the stock price in the market remains at the same level as in your call, or even decreases? This is called, respectively, “at-the-money,” or “out-of-the money.” With an at-the-money scenario, the buyer could exercise their option, but that’s unlikely. With an out-of-the-money scenario, the call contract expires, and you keep both your premium and your stock.

Writing covered calls is not a particularly advanced strategy, but neither is it for rank beginners.  Only investors with substantial assets and a willingness to accept additional risk should implement any option trading strategy.