Covered Call writing in all likelihood, is the most common and popular Option strategy employed today. In keeping with that popularity, this article is the first of three that will discuss the Upside in Part I, the Downside in Part II, and Part III an assessment or Evaluation of the strategy.
Putting on a Covered Call trade is quite simple: 1) determine the chart pattern of the underlying stock or instrument you intend to trade; 2) purchase the stock at the pre-determined price; and 3) sell the near-month Call one strike price above the purchase price of the stock. All sorts of variations of the Covered Call trade are possible depending upon what you believe will happen with the underlying security.
You could sell a Call, say, one month, two months, six months or more from expiration, and you could also sell Calls that are either in-the-money, at-the money, or out-of-the money. There are many possibilities. If you are not readily conversant with any of the aforementioned terms, it is recommended that you become knowledgeable before contemplating placing a Covered Call Trade.
COVERED CALL UPSIDE
In our example, the stock was purchased at $15, and the near-month, one strike price out-of-the-money Call, was sold for $2.50. Since one Option contract equals 100 shares, the potential profit from the Call is $250 per contract minus commissions. If you trade larger than one contract, say 10, then your potential profit is $2,500 in one month. Do I have your attention now?
That's only part of the potential profit and why Covered Call trading can be so attractive. Let's say that the stock goes up and closes on Expiration Friday at $17.75. The stock will be exercised and "called away" from you. You purchased it at $15 and are handing it over for the strike price of $17.50. That is a $2.50 per share profit, and if you bought 1,000 shares, that is another $2,500 profit for you. $2,500 (from the stock) plus $2,500 from the sold Options totals $5,000 on one trade in one month. $5,000 profit divided by $15,000 capital outlay = 33.3% profit in one month.
If the stock doesn't reach the strike price of the sold Call, then you are free to sell the stock if you wish for a capital gain, or you may choose to sell the next month Call, say the 20 strike price for whatever it is currently valued. Is this a great strategy or what?
You may use this Covered Call strategy every month of the year on multiple stocks or other securities with the real prospect of generating regular monthly cash flow. Thousands of people made millions of dollars this way during the 1990's. It gets even better. Securities move in only three directions: up, down, or sideways. With this strategy, you make money if the stock goes up or does nothing. Two out of these three ways are in your favor. You have the odds regarding direction working for you.
Before you quit your day job to trade Covered Calls for a living, there are some significant risks to consider. I will explore those risks in Part II, The Downside.
