Investing Secret: Getting Higher Returns with Covered Calls

0

Photo: Corbis

Would you like to capitalize on a little known and underused tool, which generates additional profits for your already existing stock purchases?  Covered calls remain one of the best kept secrets in the investment world.

How Covered Calls Work

Covered calls are one of the best ways to generate extra income on your already existing stock portfolios.  Selling covered calls simply means you’ll be selling options against your stock holdings, generating income from the premium.  Though this strategy creates some additional risk, stockholders are able to create huge amounts of monthly income, especially when volatility is highest.

How to Sell Calls

Investors can sell calls on any stock in which they own more than 100 shares.  Since options are traded in lots, you’ll have to sell them to the nearest hundred.  This is completed with a brokerage through which you write the calls against your existing shares.

Covered Call Example

For example, you own 500 shares of Amazon (AMZN) stock worth $128 each.  At today’s prices, you could write covered calls on your AMZN stock with a strike price of $140 per share for March options and earn $.25 per option, or $125 total.  This is the premium that other investors are willing to pay for your stock options.

How You Make Money

Immediately after selling your stock options, you’ll receive $125 at a price of $25 per contract added to your brokerage account.  Now, should the price of Amazon stock stay below the target price of $140 (a 10% increase in price) through the month of March, the investor who purchased your options will not exercise the options, and you’ll get to keep both the premiums ($125) and your stock.  However, should the price rise above $140.25 per share (the target price PLUS the price of the option) the options will be exercised, and you’ll have to sell your shares at the contracted price of $140.  Even if the stock rises to $150, you’ll have to sell at $140.

Limiting Risk

The best way to limit your risk is to issue options each month, and pick a price well out of the current trading range.  In the example above, $140 was 10% out of the current trading price, and there were only 12 trading days for the price to move above $140, which is an unlikely event.  Doing this each month could generate a full $1500 a year in extra income for a total 2.5% extra return on your investment each year.

LEAVE A REPLY

Please enter your comment!
Please enter your name here