Covered Calls

Selling calls against long stock positions is an excellent strategy for conservative investors to earn some extra income from their stock portfolio.

Example: Lets say you would like to purchase 100 shares of QQQ the Nasdaq 100 Tracking Stock with the stock trading at $27. Happy with the overall growth rate you would like to hold the stock rather than sell it. Rather than just laying back and watching the capital appreciation grow you can use options to generate some additional income from your stocks. This transaction is called a Covered Call.

With the stock at $27 you could sell one $27 Call Option in the current month for $1.10. Since each call is valid for 100 shares you would only be able to write the one contract.

Knowing that QQQ hasn’t moved dramatically lately, you may be confident that the price will not move far above $27. At expiration if QQQ is still below $27 you will keep the $110 you received from selling the calls and the 100 shares of stock. You can then go about writing another call for the following month.

Should QQQ rise unexpectedly above $27 you will have two choices. You either buy the calls back and keep the stock, or let the stock be called away and sell your 100 QQQ (1 contract x 100 shares) at the strike price of $27.

Most investors tend to write near month- covered calls for two reasons. One, the closer expiration is the less time the stock has to climb above the chosen strike price. Second, is the role time decay plays on the value of options. Within the last month of an options life time value decays more and more rapidly. Thus investors often sell options with one month remaining until expiration.  

Using ShareCharts Option Strategies for Covered Calls the entire strategy can be seen clearly. Go to Derivatives < Option Strategies and select Covered Calls from the ‘Strategy’ Drop Down Box. Enter in all relevant parameters and click ‘Update’ to view the chart.