| Writing covered calls for income is an attractive | | | | 4%, for example, but the stock makes a big move |
| strategy since it can yield profits in a variety of | | | | early on so that the trade is already up 3% in the |
| different markets. Like many option trading | | | | first week, you should definitely consider closing the |
| strategies, the trade can be made to be more | | | | position early. Not only do you lock in your profits |
| conservative or more aggressive. | | | | (and for a higher annualized return), but you also free |
| To review, a covered call is constructed when you | | | | up your funds for other covered call opportunities. |
| own 100 shares of an optionable stock and you sell | | | | 2. Roll the call option down if the underlying stock |
| someone else the right to buy those shares from | | | | trades down sharply. This one can be a bit tricky to |
| you at a specific strike price by a specific expiration | | | | pull off. If a covered call trade really begins to move |
| date. If, at expiration, the shares are trading above | | | | against you, it might be best to just close the |
| the strike price, the call option will be exercised and | | | | position and cut your losses. But if you've chosen a |
| you will be required to sell the stock at the agreed | | | | quality company in the first place and the stock has |
| upon price. | | | | fallen but isn't in a complete meltdown, you can |
| The most conservative approach is to write the | | | | always roll the call down, repurchasing the call you |
| covered call in the money, or at a strike price below | | | | originally sold (it will be worth considerably less now) |
| the current share price. The cash premium you | | | | and then re-selling another one at a lower strike price. |
| receive will consist of the amount the option is in the | | | | This will net you more income (which equates to |
| money as well as additional premium based on time | | | | additional downside protection) but it does come at a |
| value (providing the strike price isn't too deep in the | | | | price--if the stock rebounds sharply, you'll most likely |
| money). You'll receive less time premium (net income) | | | | be whipsawed into a loss. |
| with this approach, but the advantage is that you'll | | | | 3. If the stock trends lower, close the position early |
| gain much more downside protection since the stock | | | | and wait. This is similar to Example #2 above, but |
| will have to drop a lot farther for you to lose money | | | | works better on stocks that have drifted lower |
| (it would have to trade below the the strike price | | | | rather than those that have fallen sharply. It also |
| less the amount of time premium received). | | | | works better as part of covered call strategies used |
| Writing the call at the money, or at a strike price | | | | by investors with long term portfolios who are in no |
| that's very close to where the stock is currently | | | | hurry to sell their stock. If a stock is steadily drifting |
| trading, will give you more time premium but less | | | | lower so that the original call sold has lost a great |
| protection. And writing the call out of the money by | | | | deal of its value and with plenty of time remaining |
| choosing a strike price higher than the current share | | | | before expiration, you might want to buy back the |
| price will give you the least amount of downside | | | | call and wait to see what the stock does next. If the |
| protection but will produce the largest profit if the | | | | stock begins to rebound, you can resell another call |
| stock trades significantly higher. | | | | at the original strike price once that call has increased |
| It's important to realize that while the original strike | | | | in value again. If, however, the stock continues |
| price chosen is of critical importance to how the | | | | lower, you can eventually write the new call at a |
| trade plays out, there are additional adjustments and | | | | lower strike price, a sort of slow motion rolling down |
| modifications you can also make to the covered call | | | | of your original covered call trade. |
| position once the trade has been set up. Here then | | | | Covered call writing, when practiced prudently, is a |
| are three such trade adjustments to maximize your | | | | conservative strategy that can generate attractive |
| covered call income: | | | | streams of income. It's also a flexible strategy that |
| | | | can be modified to maximize that income. But it is |
| 1. Close the position early if the underlying stock | | | | not without risk and it shouldn't be approached |
| makes a big move higher. This is an especially good | | | | without due diligence or an awareness of the |
| idea if the stock makes a big move early on in the | | | | potential pitfalls. |
| option cycle. If the maximum gain on the trade is | | | | |