If you’re on the lookout to boost your investment income, then covered calls could be an effective strategy.
When trading a covered call, you, as an investor, will sell a call option contract on shares you already own. You can sell enough contracts to cover your entire underlying position or just part. Remember, options trade in contracts, not shares. Each contract represents 100 shares of the underlying asset. When you sell a call option, you give the buyer a right (not obligation) to buy the said shares. Selling covered calls is a method to boost income while owning an underlying asset.
The option you’re selling here is covered, meaning you’ve got sufficient shares to cover the transaction according to the option you will sell.
There’s one problem with using the covered calls strategy. As an investor, you limit your chances of earning a substantial amount once the stock price exceeds the strike price of your call.
Apart from that, once the implementation has been understood and a covered call screener is used to determine the details of the call, any investor can benefit.
Ideally, you also want to read about covered calls in depth before you begin trading.
What is a Covered Calls Strategy?
A type of options strategy, covered calls are often considered to be a less risky conservative approach to options trading. This is because it reduces the risk of stock ownership and doesn’t add leverage common with the use of many options strategies. In the worst case, you might have to sell off the shares you own or the value of your shares decreases so much that it becomes less than the premium you earned. Either way, the loss is defined and easily calculated.
That said using a covered call stock screener like optionDash can help you find the best covered call combinations.
Profiting on Covered Calls
At the base of it all, we have something known as premium. This is a particular amount that the option buyer pays the seller. They gain the right to buy your shares at the strike price decided beforehand.
We can call it a cash fee that will be paid when the option is sold. Even if the option is not exercised the premium will be received by the seller.
The maximum profit of a covered call is achieved when the stock’s price reaches the strike price of the option. Remember, when you sell a covered call, you are forced to sell your shares at the strike price of the option.
Are you confident enough to sell covered calls yet?
If not, then keep reading, because we’re going to briefly cover the pros and cons of covered calls.
- You can set a target selling price for the stocks you own and wish to earn a premium through
- Covered calls provide you with an additional income on the shares you own
- You can define and calculate the risks that come when you decide to implement the covered calls strategy
- You own the stock until the options expire. If the price declines, you participate in the losses
- You’re going to limit the gains you could have achieved through an increase in the stock prices
- Profits are typically taxed at the short-term capital gains rate
A covered call screener should provide sufficient aid in managing your covered calls and provide insight on the next steps. Check out optionDash now!
Mistakes to Avoid
Creating a profitable portfolio is not a cakewalk. Investors may face ups and downs due to the uncertainty of the market. For a newbie, the risks with covered calls are similar.
Let’s take a look at some of the most common mistakes you want to avoid when selling covered calls.
- When you write an option on the stock you already own, it is known as a covered call. On the other hand, the same process followed without owning underlying security or stock is known as a naked call. Writing a naked covered call is as risky as it gets. The upside potential is limited but the downside potential is unlimited if the trade were to go against your judgment. Try not to get into writing naked calls if you don’t have a strong grasp on the excessive risk.
Use a covered call screener to check whether you’re making the right decision.
- You may also hear investors saying that they made a trade that didn’t work for them. The worst part of it was for them to be unprepared to bear the loss. Before you decide to trade, you must determine how much money you’re willing to risk and if things were to go south, would you be able to bail out of the trade. Study the market thoroughly and create a risk management strategy. Talk to experts, if you must, before selling covered calls.
- Always remember, you do not want to sell at the wrong expiration date or strike price. You want to have a solid understanding of the rewards vs. risk scenario involved with covered calls. Choosing a strike price will determine the amount of income you collect in exchange for the upside potential beyond the strike.
Towards the end, there’s only one thing you want to remember.
Being thorough in your research and taking small risks at the beginning of your trading journey will take you a long way. For a successful implementation of the strategy, you want to choose the right company to sell your option on. Once that is sorted, you’re only left to choose the right strike price.
This will come with practical experience.
Read as much as you can. So, take a look at the difference between covered calls and cash-secured puts here. You should be able to get a better idea of the path you should take.
The simpler the covered call, the better.
If you’re ready to expand your trading techniques and begin using covered calls, then use optionDash as a tool to screen your stock and options data. We use proprietary scoring systems that help you pick out the right stock for your plans. It’s an easy-to-use screener made to make your life easy!
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