Dan Picinich Uncategorized

Covered Calls 1

Options trading written on black piece of paper.

A covered call is an investment strategy that combines a common stock with a call option on the stock. You would own the stock, for example, 100 shares of
Amazon (symbol AMZN).

The call option is a contract, between the buyer and seller of the option, where the seller gives the buyer the right to call away, or take, the stock from the seller at a specific price (strike price), until a specific date, in the future. For the opportunity to call the stock away, the buyer pays a “premium”, or a fee.

In the Amazon example, the stock is currently trading at 196. I can sell a contract, that expires on Friday, 3/21, that allows the stock to be called away if it reaches 200 (strike price). In exchange for this right to call the stock away, I would receive a premium of $1.49/share. Options trade in “contracts”. Each contract covers 100 shares. 100 shares X 1.49 = $149. $149, less commissions and/or exchange fees, is what would be credited to my account, once the trade is completed.

A covered call strategy is considered a neutral, or slightly bullish strategy. In this example, we are able to sell the call, receive the premium, and not have to worry about losing the stock, until it reaches $200/share.

Why “slightly bullish”? “Slightly bullish” indicates that you believe that the stock can go up, but will not skyrocket in value, for the duration of the option contract. If we expected the stock to go to 210 or 215, we wouldn’t risk getting it called away for a premium of $149.

The call is considered to be “covered”, as we own the stock to cover the call, if we had to. If we did not own the stock, the call would be considered a “naked call”.

Bullets

  • A covered call strategy involves the sale of a call option on a stock that we already own.
  • This strategy is considered to be slightly bullish, as we feel that the stock could go up, but not above and beyond the strike price.
  • The buyer pays the seller of the option a fee, or premium, for the right to call away the stock.
  • The seller of the contract can still participate in the gains of the stock, all the way up to the strike price.
  • Regardless of the price of the stock, at expiration, the seller will keep the premium.