The covered calls
options trading strategy provides traders the ability to generate additional income from investments in a neutral market. An options trader who wishes to benefit from a fairly neutral market may consider selling covered calls. Selling covered calls is the selling of calls on an asset (stock) owned by the trader at a price point which he or she is wiling to sell this asset (stock) at.
The time decay benefits to the side of the options seller and the closer the time to expiration, the more the sold call looses value, thereby increasing the likelihood of profit - even in a neutral market.
The following trading strategy delivers some benefits:
- A trader receives a premium when he or she sells call options on a previously purchased stock that he or she is willing to sell at a specified price.
- If the stocks a trader owns is below the strike price upon expiration the trader retains the premium as a profit.
- If the stocks owned is above the strike price upon expiration the trader may have to completely or partially return the premium or even more. However, the trader will receive a higher profit through the sale of the owned stock's rise in value.
- If the stocks drops in price the trader's loss is reduced by the premium received from the sold options calls.
By selling covered calls the options trader may see limited profit in the event of a strong up-rally when the call options would probably be exercised and the call seller would be obliged to sell the asset at the strike price. If the price rockets upward the trader could even experience losses.
The following options strategy could be used when a trader owns stocks and he or she expects a decline in the stock's price however is not willing to sell the stock. In this case a premium received for options call helps to offset the price decline.
As a rule with this strategy the out-of-the-money options calls are sold. The in-the money options call could be sold as well, and in such case the collected premium is higher, however the risk is greater as well. Options 1-2 months to expiration would deliver a lower premium, however they are considered less risky.
If a trader expects the owned stock to rise in price, the covered call options trading strategy can be used to produce additional income while he or she stands on the position waiting to sell the stock at a premium. If a trader expects a strong downside move, it is probably better to sell the owned stocks.
