What is a covered call? A covered call is a stock option that you actually create the option by writing or selling a call option against a stock that you already own. First of all you have to have a brokerage account, you have to own the stock, at least 100 shares. Calls are sold in increments of 100 share. The start of the process is called sell call to open, SCO.
Covered call example: Let's say that you own 300 shares of Ford Motor Company, as the owner of the stock you could sell the March covered calls today for $.50 per share. Your profit is 300 x .50 or $150 minus commission on the trade.
Considering that the current annual dividend payment of Ford is only $.40 cents or 2.7% by selling the call option every quarter you could potentially generate another $2.00 per share of income from the Ford stock which would increase the yield from your Ford stock to almost 16%.
Cisco Systems covered call example: Let's say that you own 300 shares of Cisco, as the owner of the stock you could sell the April covered calls today for $.95 per share. Your profit is 300 x .95 or $285 minus commission on the trade.
Considering that the Cisco does not pay any annual dividend by selling the call option 3 times in 2005 you could potentially generate $2.85 per share of income from the Cisco stock which would produce a yield of almost 15%. Based on the fact that Cisco has not done much in the way of appreciation in price over the last several years this may have not been a bad strategy.
Profit potential of covered calls. The profit potential for a covered call can be as high as 3 to 10% in a one or two months. For the latest on covered call premiums goto coveredcalls.com.
What is the risk in a covered call? A covered call has one risk, if you sell a covered called you have the risk that the stock could go up beyond the strike price and you stock will be assigned to someone else.
For example: If you sold the Ford March 15 calls and the stock went to $20 you keep the $.50 per share from the covered call, however your stock is assigned to someone else for $15 and you do not receive the benefit of the appreciation of the stock price.
If you enjoyed this post please Subscribe to Strategies for Life
Interested in books on covered calls check out the titles below!