If you’re not familiar with options, you may have heard that they are very risky and dangerous. Well, they can be. It’s been reported that about 80% of options expire worthless. So, why would you want to invest in something that is worthless 80% of the time? No, I’m talking about “writing”, or selling, covered calls.
Let’s say you have 100 shares of ABC stock. It’s trading at $47/share. You may be able to sell an option a couple of months out with a strike price of $50. That means if, on the strike expiration date, that ABC is trading at $50+, you have agreed to sell your ABC stock at $50. You get $50/share, whether the stock is at $50.25, $60, $100, or more.
Wait, why would you do this? Well, because you get paid to “write”, or sell, the covered call. Moreover, if the stock closes <$50, you keep your stock and live to do this again. And, whether your stock is sold and taken from you at $50, or the stock is <$50 on the expiration date and you keep your stock, you always keep what you made by selling the option contract.
This is a touted strategy for incremental income, especially for those in retirement or looking to generate extra money from their portfolios.
A few things that I would like to note that often isn’t discussed. A couple of things may happen in the time that you have a covered call written on a stock you own in your portfolio: (1) it may go above the strike price, but you would like to keep your stock; or (2) it may begin a downward trend and you just want out of the position. In both cases, you can always “buy” the same call to cancel your written call position.
And, if you have enhanced options privilege with your broker, and you’ve been assigned on a written covered call, you can always sell an uncovered, or “naked” put, on ABC stock to possibly reacquire the position. In doing this, you write an option that says that if a stock is at or below a certain price, you will purchase the stock at the strike price of the option on the exercise date.
So, let’s say you had ABC stock, you had written a covered call, and you were assigned at $50, as ABC was at $52 on the exercise date. You could then write an uncovered put at $50, so that if the stock trends back downward you could reacquire it, by being assigned to purchase the stock at $50 if it closes below $50 on the exercise date. And if it doesn’t, well, you’ve made the premium from selling the put; just like with writing calls, when it comes to writing puts, you keep the premium no matter what happens. And, you could write another uncovered put if you are not assigned.
Finally, the old market adage of risk v reward is abundant in options. Lower volatility stocks have lower prices for options; higher volatility stocks have higher prices. So, you can’t expect to make 20% on an option sale on a boring, low-volatility utility stock, but you can expect to make 20% on an option sale on a crypto mining stock or a Reddit-pumped stock. Higher reward entails higher risk.
I know these concepts seem complicated if you are not familiar with them. My advice is to read a good primer book on the subject, such as this one, study options chains, and learn.
DECADES to Wealth 