What is a covered call and why should you be using it when you are investing in the market?
It’s a very popular method and form of investing that many people use daily. It is true that typically it is employed by more seasoned investors but the truth is that you can probably use a covered call even if your experience in investing is limited.
The basic premise behind a covered call is very easy to follow: it is an approach to investing that has you writing and offering a call option against a stock that you currently already own. In a sense, you are betting against something that you already have faith in.
A covered call makes a lot of sense when you consider the price of premiums that come with each stock purchase that anyone makes.
When you buy a stock, no matter the price, you are on the hook for paying a premium, or a fee that must be paid to whoever is providing you with the shares. When you are using a covered call, you can make a good sum of money off of those premiums.
Whenever someone buys your shares at a set a price, you are going to bring in a sizable amount of income.
How A Covered Call Works
The thing to always keep in mind with a covered call is that you are buying a share of stock for something that you already own.
Therefore, the first step that you should take is to buy shares of said stock. You can choose to do this using any method that you prefer, and keep in mind that you don’t have to buy the new shares with the same method that you bought the previous ones.
It is important to remember that you should buy shares of stocks that are typically quite stable and reliable.
Volatility can affect every part of the market but it’s vital that you choose a stock that can typically rise above all of that.
After you buy your stock, you need to sell call options against that stock. This will give any buyer the chance, but not the obligation, to buy the shares when the time comes that the stock hits a predetermined price.
Strategy 1: The Win-Win
In this case, you are assured a brief profit because having to sell a call option basically locks in the stock's purchase price. Along with this, sellers also get to also keep the premium fees that the call option buyer gave you. Thus, everyone benefits from the circumstance.
Strategy 2: The Premiums Pay Off
With this strategy, you can get some sort of protection from any potential downside because of the premium that you are able to earn by selling your call option. This is good because the premium might actually cover the cost of the losses that you might have experienced if the value of your stock dropped in price.
Some people pursue covered call options solely so they can make money off of the premium fees that come with a sale. Sale by sale and piece by piece, sellers are able to accumulate a good amount of money over time.
Strategy 3: The Premiums Keep Everything Even
When the value of your stock stays the same without many changes, the profit that you would gather from a sale might only be equal to the value of the premiums that you have to pay or receive. This isn’t a great strategy for a covered call.
When it becomes apparent that you are looking to not turn a profit, but not lose much either, it is probably best to make a future plan for your covered call and then execute it.
Strategy 4: Make A Plan
When you are making a covered call on the market, you should have a road map laid out for yourself and have an idea of how you want to act during the good and bad of the market.
You should have checks and balances in place for your own portfolio. And you should stick to this plan closely because you will have ideally made a plan that feels right for the sort of investor you want to be.
Strategy 5: What Sort Of Investor Are You?
You need to follow the strategy of being the sort of investor that you want to be. You need to know what your main goals are and what you hope to achieve when you enter the market place.
Pursuing covered calls is a good idea for investors but only if they are strict and follow the plans and rules that they care for themselves.
It is important that before you start your first covered call, you know the sort of investor you are hoping to be. Are you wanting to be someone who is very adventurous and daring, taking risks with the chance of a huge upside on your investments? Or do you want to be the sort of investor who is a bit more calculated and smarter, but maybe doesn’t make huge gains quickly?
Whatever path you pursue, it is vital that you figure this out before you make your first investment and well before you make your first covered call.
Strategy 6: Only Make A Covered Call On A Stock You Trust
The entire basis for a covered call is that you are buying an option on a stock or asset that you already own. Therefore, you should be purchasing the new asset only if you feel comfortable putting more money into that stock and company.
Strategy 7: Buy When The Premiums Are High
The only way you stand a chance to make much money in a covered call is if you are buying when the premiums are high. You will be making money based on the value of the premium so if the value of it is low then you should wait until it is higher, otherwise you will not be able to make a solid profit on any possible upcoming sale.
When To Use A Covered Call
Typically, the covered call technique is usually initiated 30 to 60 days prior to the expiration date of a call option. However, the investor's objectives will determine when to carry out the strategy at its best. In other words, it's different for every investor depending on what they want, what they need, and what they are comfortable with doing.
It's better if there isn't much of a gap in between the price of a share along with the strike price. You must be in a situation in which the calls will be allocated if your objective is to sell both the stock and the call.
The price of any possible stock for sale must sit just above strike price all the way to the expiration of the deal for this to occur.
Some investors will simultaneously sell calls and buy equities at the same time. This method, known as a buy-write, is employed to lower the cost of previously acquired equities. Covered calls don't have any extra margin prerequisites because you already own shares of the stock in question.
Calculate your potential profit from the plan, then set your premium in accordance. When selling short choices, traders will be paid more if volatility is high. Due to their preference for owning the stock, some investors offer call options at a large premium in order to reduce the likelihood of losses from a decline in the price.
Final Thoughts
Using covered calls has a dual purpose, and in a sense hedges your investment against the call to help protect some of the risk associated with trading options. Using these covered call option strategies provide you with different approaches that may help you achieve results.
Keep in mind that you need to own the associated stock (or be willing to own it), be prepared to sell the stock if the price is reached, and understand there are limitations to premiums you can gain. There is risk, but the covered call has lower risk than some options out there.
Which strategy will you try out first?
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