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Sunday, February 8, 2015

How to Write a Covered Call

So you've decided to expand into trading options, instead of just buying or selling stocks.
One of the simplest ways to start out in the options market is through
selling covered calls. So permit me to summarize in really simple language, what the process entails to start
writing covered calls.

When you are "writing" covered calls you are actually "selling to open" a covered call.

A covered call is different than a plain ole "call option" because you actually literally own at least 100 shares of the stock that you are writing the call on.

So the first step to being able to write a covered call is by purchasing at least one hundred shares of a stock that has "options trading" available on it.

Covered calls can only be written on chunks of 100 shares at a time. One hundred shares is considered
"one contract" which you are going to write the covered call option on. There is a fee that your brokerage will charge you based on how many contracts you are going to involve in your covered call option. If you own 500 shares you could potentially write 5 contracts for covered calls.

Next you need to choose a "strike price" at which you are going to sell to open your covered call at.
The "strike price" is the price at which you give your covered call option buyer the right, but not the obligation, to buy your shares at. I suggest you pick a "strike price" that is just a little bit higher than the price that you originally paid for the shares. That is called a "near the money" covered call.
You can ask a higher premium for a covered call that is "near the money" than one that is way priced out of orbit.

You need to also choose an "expiry date" at which the call option will expire. Usually the farther into the future that the expiry date exists, the higher the premium you can ask. Once the expiry date has passed, the buyer of your call option no longer has the right to buy your shares anymore.

You are going to have to decide what price of premium you are going to ask buyers to pay for your covered call option. This premium will be estimated upon the most recent "bid and ask" prices posted for covered call options. An example of a covered call option premium might be $1.25 per contract. To discover what your earnings will be from "selling to open" a covered call sold at $1.25 for one contract, you would simply multiply the premium $1.25 by 100 and that will give you the sum of $125.00 which is the total premium that will be paid to you. Be sure to calculate and inquire of your brokerage as to what commissions and/or fees you will incur from selling to open covered calls. There will most likely be higher fees if the buyer chooses to exercise their right to buy your shares at the agreed upon strike price.

Newbie and beginner investors usually face much higher commission fees than investors with larger portfolios. The sad truth is that large portfolios usually have their commission fees waived because of the largess of their account balance. Therefore, if you are going to do an options play, and you are a small time investor, you will want to keep accurate track of all commissions/fees because they will definitely bite a significant chunk out of any profits you earn from writing covered call options.

The "premium" is the price that you are asking buyers to pay you for the privilege of  owning your covered call option. If you are not sure if you are willing to part with your shares, then you are not ready to be selling covered call options. Last I heard, there is about a 25% chance that most covered call options are actually "exercised" or "assigned". When a covered call option is "exercised" or "assigned" it means that the buyer of your covered call option is exercising their right to buy your shares at your agreed upon "per share" price.
Those who sell covered call options are prepared for the possibility that they may be forced to sell their shares. Therefore, selling covered call options are only a good idea for those who are not personally or emotionally attached to permanently owning their shares.

Well, that's about all.... those are the basics, written in my own casual language. The rest of the process is just about waiting to see if a buyer is willing to buy your covered call option, and then waiting for the deal to          "settle". Be blessed and prosperous.

C.


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