High Risk Covered Calls or Low Risk Covered Call Options

Are you an option trader ? Do you sell covered calls?

Today I just wanted to discuss how you can influence your levels of risk by several key factors when and if you sell covered calls.

For brevity, I am going to assume that you all know how to ¨sell to open¨ covered calls. If you do not know what  a covered call option is.....then this post may not be helpful.

What raises risk in a covered call scenario?

permit me to draft a list:

• Selling covered call options way out into the future...such as 6 months or even 2 years into the future. The future is unknown and the more we try to predict long term results....the more risk we may encounter....due to unexpected market movements.
• Using leverage to finance the purchase of the underlying asset. Using margin debt to finance your purchases of the underlying asset adds more risk to your portfolio. Not only must you prepare for interest payments on the money you borrow in your margin account, but you must prepare to prevent a margin call on your account, when/if your buying power becomes challenged by negative market forces or poor investing choices.
• Selling covered calls on equities that have an unproven financial record can/may add more risk to your accounts. When investors choose to sell covered calls on publicly traded companies that have no positive financial reports, they add unintended risk to their holdings.

There are several ways to minimize risk when selling covered calls on your stock portfolio. 

Permit me to draft another list:

• Sell covered calls on stock that you have paid for in full....(without leverage)
• Sell covered calls on companies with proven sound financial management, that produce healthy price to earning ratios(p/e ratio) and have a good reputation. Have a healthy respect for positive earnings. What is trendy is not always a ¨good bet¨.
• When you want to withdraw money from the premiums you have collected by selling covered calls, only do so after the contract has expired or been closed or assigned. This simple tactic will prevent unnecessary stress if/when a covered call position runs in a direction that you did not expect.
• Last but not least...do not lower the strike below your cost. This is very important, so that you do not risk losing money on the difference between your net cost of stock and the potential inflow of cash if/when a covered call that you have sold gets ¨assigned¨. To be fair, it is important to note, that there may not always be a strike price available at the correct price point to make your trade profitable. Therefore you may have to just ẅait and hold onto stock that needs time to recover from a market dip. This is another reason why it is prudent to eliminate the use of debt/margin/leverage when purchasing equities....so that you will be able to weather market ups and downs..... while maintaining a stress free and dignified investing experience.

Well.... that is all friends, for today. If you are an option trader or investor, I am sure you have discovered a plethora of methods you can use to control and/or define your risk. There is nothing more important in investing than controlling risk.

May God bless your trading and investing as well as your learning journey.

Peace,

Carla.

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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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