Making Money With Covered Calls | Online Options Trading

admin — Wed, 06 Jan 2010 09:04:09 +0000

Making Money With Covered Calls | Online Options Trading

If you don’t have much of an appetite for risk but still want to invest in the stock market, or if you’re a complete beginner who wants to get his/her feet wet in the world of investing, you have an excellent vehicle to get started, and it’s index funds. To make a long story short, an index fund mirrors the performance of the market it tracks. So if you invest in an index fund that mirrors the performance of the whole stock market, you’ll get the same returns as the whole market. Historically, through the ups and downs, it has averaged about 10% a year. Although that may not seem much, compound interest really adds some major kick to it, and you might be surprised to learn that just doing so will earn you returns that are higher than those of 70% of active fund managers out there.

But that doesn’t mean that you should settle for what the market gives you. There’s nothing wrong with trying to get a higher return rate on your investment portfolio. It’s not about throwing caution to the wind and going exclusively with the high risk, high reward investment vehicles, but it’s about allocating a small portion of your money to other money-making opportunities in the stock market and boost your overall returns by a few percentage points. To do that, you’re going to need a plan: no one makes money by investing blindly.

What Is A Covered Call?

Many people consider covered calls to be one of the most conservative strategies for trading options. As a result, it’s one of the very few options trading strategies that are allowed inside an IRA account. This is a technique that works best with stocks with medium volatility.

In it simplest terms, a covered call is where you own some stock and sell an option to someone else to buy that stock at a specified strike price to generate some income. Here’s how this works. Let’s say you currently own 1,000 shares of company ABC, and each share is worth $5, so your portfolio is worth $5,000. You might be perfectly content to let your stock grow and have no plans to sell the stock, as you’re holding it for the long term. Because you own the stock, you can sell an option to someone else and earn some immediate short-term income.

How Do You Make Money?

People will pay you, say, 50 cents a share today for the right to buy a 30-, 60-, or 90-day call option at, for example, $6 a share. If you sold 10 contracts of ABC stock for 50 cents, you would generate an income of $500 within the time frame of the option you sold. Usually 1-2 months. This is an instant 10% return on investment. Ex: $500 / ($5,000) = .10 or 10%.

Now let’s clear things up a bit:

One contract controls 100 shares of stock, so 10 contracts control 1,000 shares of stock. In the aforementioned example, you would have sold 10 contracts.
There are two kinds of options, calls and puts. In this example, the investor buys a call option: the right to buy (or call) a specific stock at a specific price. Investors buy calls when they expect the price of a stock to rise.
The $6 price that the investor locks in for ABC stock is called the strike price.
The $500 he paid for the option is called a premium
All option contracts expire on the third Friday of every month. A June call contract expires on the third Friday of June

On expiration Friday, you do nothing, just let the option expire. Three things can happen.

The stock appreciates in value and goes above the strike price to, say, $7. The investor can “exercise” his option, in which case you’d be legally obligated to sell it to him at the strike price of $6. You receive $6,000 and make $1,000 in profit from the sale of your stock, so your total profit is $1,500 (30% return on your $5,000 portfolio) when you add the premium. As for the investor, he can sell the shares immediately for $7,000 and makes an immediate $1,000. He deducts the premium he paid you ($500) and is left with $500 profit, which is a 100% return on his investment of $500.
The stock remains around $5. In this case, the options you sold expire, with no obligation for you to sell them. You keep the $500 premium, which represents a 10% gain on your $5,000 portfolio, and you’re free to repeat the process. The investor’s contracts are worthless and he loses his entire premium. Better luck next time!
The stock price declines below $5. The result is exactly the same as the previous example, except that since you’re holding this for the long term, you don’t mind minor fluctuations in the stock’s price. Even better, you’ve hedged your losses with the $500 earnings from the premium. And of course, you can rinse and repeat.

Why would you be willing to write covered calls? Because according to some experts, the options expire worthless 80% of the time. In other words, you pocket the premium 8 times out of 10. Still, there’s risk associated with this: if the stock price increases substantially above the strike price, you lose potential profit. You will still make the profit from selling your stock plus the premium, but the other investor gets the big payday. If you own stock, you might as well make some money from it, especially since you are not married to it.

Online Options Trading Education

If you are already in trading and you are not having the success you want, it is better to step back and master the fundamentals of options trading. Your savings and your nest egg are too precious to be simply thrown away on an impulsive trade or something your broker recommends but you don’t really understand. Courses about options trading are available both online and offline which makes the study and learning of options trading both easy and accessible.

Courses are offered by traders of sufficient experience, private financial educators and the boards of exchange. Do an Internet search for “teach me how to invest“, and you’ll find a plethora of offers. Chicago Board Option Exchange, main trading exchange for American options, has extensive online tutorials covering terminology and the regulations that governs domestic option trading. You can also enroll yourself in a number of specialty niche courses, such as commodities, bonds, or futures.

Real-Time Options Trading

One of the biggest advantages to online options trading is that you can get real-time updated statistics on the options market just like the stock market. You can monitor and observe trends right from the comfort of your own home. And if you need assistance or needs to seek advice, you can use email, help desk, instant messaging or even skype to communicate with your broker or fellow investors.

Online options trading is now probably the most popular way of trading options. It’s one of the best ways to put your covered calls strategy in practice, because the process is fast and easy to grasp. No need for face-to-face trading: all you have to do is log into your trading website of choice and do all your transactions with a few clicks. Because the actual trading is very quick, it leaves you more time for research and analysis of options trading opportunities.

Online Options Trading Forums

Options trading forums allows you to discuss options trading with fellow like minded investors. It is a good place for beginners new to options trading to hang out and learn from other more experienced investors. Online options trading provides so many benefits over traditional trading and it is not difficult to get started since many online options trading websites provides faqs and how to manuals to get you started.

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Making Money With Covered Calls | Online Options Trading