Last week I hosted a live chat to discuss
"My Game Plan for the Year Ahead - Earn $1,200 a
The response was overwhelming - hundreds of you tuned in for the
hour-long webinar, and many of you came equipped with some
excellent questions. While I was able to get to quite a few of
those questions "on the air," I was not able to answer all of
them. In today's
, I will address some of your most pressing options questions
about how I use covered calls.
If you missed the recent live event, don't worry. You
click here to watch the recorded webinar in its
Let's get to it.
This week I am introducing a covered call strategy within my
service. (I discuss this strategy in my
.) The strategy should serve as a valuable addition to the
service beyond the credit spread and Apple portfolios that I
I believe all self-directed investors need to take a serious
look at covered calls. This is especially true for those who feel
options are a highly risky trading vehicle.
A covered call is a conservative options strategy whereby an
investor holds a long position in an asset and sells call options
on that same asset to generate increased income. Unlike
buying options outright, this strategy allows you to take a
conservative stance so you can sleep well at night.
All you need to initiate the strategy is 100 shares of
stock and a highly liquid options market. By highly liquid,
I mean heavily traded options that that have narrow bid-ask
If you own at least 100 shares of stock, then you have the
ability to "sell a call" against your stock (assuming it has
options, which most do). Remember, 100 shares of stock equals one
One of the stocks I will use for covered calls is
Let's say that you've collected 200 Facebook shares since its IPO
last year. Furthermore, you believe in the long-term prospects of
the company and have no intention of selling the stock any time
soon … it's a long-term investment.
With Facebook trading at approximately $31.50, the 200 shares
are worth $6,300. Again, you like the stock's long-term prospects
but feel in the shorter term that it will likely trade relatively
flat to lower, perhaps within a few dollars of its current price
If you sell two March (expires on March 15, 2013) call options
on FB at the $36 strike (this means you are selling the right to
buy your shares for $36 at any point up to March 15), you could
collect $71 per contract, or $142 for your 200 shares. Do this
eight times per year and you could bring in $1,136. Not a bad way
to tack on an additional 18% to your FB stock annually.
By comparison, if you went out to the $38 strike you could
bring in $40 per contract, or $80 total. Eight times a year
totals $640, adding 10.2% annually to your holding.
Obviously, the further you move the strike price out away from
the current stock price, the higher your probability of success
(defined as your shares not being "called away"). However, the
more conservative your approach, the less option premium you
Returning to our Facebook example, one of three scenarios will
1) FB shares trade flat (below the strike price) - the
option will expire worthless and you keep the premium collected
when you sold the calls. In this case, by using
the covered call strategy you have successfully
outperformed the stock.
2) FB shares fall - the option expires worthless, you keep the
premium, and again you outperform the stock.
3) FB shares rise above your strike price - the option is
exercised (i.e., your stock is called away) and your upside is
capped at your strike price plus the option premium collected.
For example, if you collected $40 per contract at the 38 strike,
the covered call strategy will underperform the stock at any
price above $38.80. (Note: you are selling two FB contracts
because you own 200 shares of the underlying stock.
Remember, covered calls make money when stocks are slightly
higher, flat or down. You only get the underlying stock "called"
away if it rises significantly.
Given how this conservative strategy works, why would any
investor choose to shy away from such a proven income strategy
that has outperformed the market and dividend-paying stocks over
the long term? This is why I decided to introduce this strategy
You can learn more about how I safely use options for both
income and to steadily grow my investment account by clicking
Editor and Chief Options Strategist