My Most Frequently Asked Question: What is a Covered Call?

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what is a covered call Several times a week I receive a similar question from curious investors: "How can I earn more income on the stocks I own in my IRA?"

My response is typically short and sweet… covered calls .

Covered calls not only allow me to earn more income from the typical blue-chip dividend stocks I own within my retirement account, they also allow me to bring in consistent income in my non-retirement accounts.

So I'm sure you are asking what is a call? What is something that is covered and why would I bother using the strategy?

OK, first question: What is a call? If an investor wants to buy a stock, they can do so at a lower price by simply buying an option …more specially, buying a call.

Buy a stock = buy a call.

Say you own a stock and someone wants to buy an option to buy a stock. You have the right to sell that person an option to buy your stock, or to call your stock away from you at a specific price within a specific period of time. Because you own the stock, it's called a covered call. There is one stipulation: you must own at least 100 shares of a stock to sell a call.

1 call option = 100 shares of stock.

Let's go over a very basic example.

If you bought a stock at $25, your cost basis is $25. Another investor is willing to pay you $3 for every share you own to call that stock away from you at $30 a share on and before the option expires in two months. Essentially, you are getting $33 a share if the stock gets called away from you because the buyer of the option paid you $3 a share to do so.

Now why would the buyer of the option want to call the stock away from me? Simply stated, the stock is trading above $30 a share. If the stock were only trading at $28 a share, the buyer of the option is not going to pay $30 for it, so you made the $3 a share and never gave up your stock.

It is an incredible way to make more income on the stocks you currently own as long as you don't feel bad if that stock goes to $40, $50 or $60 and someone calls it away from you at $30.

That is why I only use a covered calls strategy on blue-chip , dividend-paying stocks like Microsoft (Nasdaq:MSFT), Intel (Nasdaq: INTC) or General Electric ( GE ). These types of stocks are not volatile. The chance of them advancing 20% in two months is slim to none.

I'm actually in the process of filming an educational series on covered calls and selling puts, so stay tuned. I will be sure to announce when the course is ready to go. Until then, please feel free to email me if you have any questions on covered calls.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Options

Referenced Stocks: GE

Wyatt Investment Research

Wyatt Investment Research

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