Covered Call Options Strategy for Beginners (How it Works to Make You Money)

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A lot of people that purchase stock eventually realize they can make a little bit of more money from selling calls on it. This is known as a covered call strategy.

Basically what happens is if your stock is just hanging around, not doing too much, you could sell calls against it, meaning premium. You could sell some kind of insurance premium to other people that are interested in getting the stock at a certain price or rate. This is what you can do if you have ownership.

Think of this as if you own a certain guitar.

You’re okay to part with it as long as there’s a certain price so you could list it on eBay.

Even though the normal rate or price of this guitar may be $500, well what you could do is, sell it at 950 and your okay to part with it. So it may not happen for a while but let’s say all of a sudden the demand for those guitars goes up.

That guitar becomes an antique because that company went under or something like that.

Now all of a sudden your guitar is worth a lot more. This is what you’re doing when it comes to a covered call strategy.

Let’s break this kind of concept in detail.

How does it work?

Risk Profile Picture

What does this represent? The stock price is on the bottom. Let’s say I purchased the stock at about 170 dollars per share.

Now as the price goes up, I make money. As the price goes down, I lose money.

So if I am interested in owning this stock for a long time, I would just own it and hold on to it.

But the problem is, stock doesn’t always go up, right? Sometimes it stays still, sometimes it pulls back.

What can you do? What a lot of investors do in order to make a little bit more money from holding their stock is they sell a call options on it.

So what does that really do? Well what it means is I flatten out my curve. I flatten out my profit and loss picture.

That means I can only make a certain amount of profit up to that point. Normally what would happen is you would keep making all this additional potential profit if the stock price kept going higher.

But with a covered call strategy, you flatten it out. Then you would only maximum make $1200.

In order to make this work you need to own at least 100 shares of stock. Then what you do is you sell one call contract higher than the current price.

You could sell one even lower if you want but more than likely your stock will get called away.

Advantage and disadvantage

  • The stock stand still, you still collect the $430 dollars and you keep your stock.

You’re still back at your current price or maybe even higher a little bit.

  • The stock moves down, you lose money.

The good news is, you make money from the call you sold and you keep the stock.

  • The stock goes up all the way to the moon, so this is called moon money.

The problem is you sold this call contract (at $430), so stock goes up you make money until your strike. Then you have to sell your stock but you make the call premium money. So you still make that $430.

Now question is, can you get out of this early?

Let’s say it starts moving against you. It’s going up but you want to keep your stock, you could get out of it early but it may cost you a little bit. The downside with this strategy is this. It’s gonna protect you a little bit if the stock goes down — it’s not a lot.

If the stock goes up and it goes up a little bit, you’re fine because you’ll still get to keep your stock and you’ll get to keep the premium.

If it explodes, you just won’t make as much. So your greed will have to subside, you’ll still make money but you won’t make as much. From my experience, as most stocks do not explode to the moon.

It’s not typical, it’s not the normal case. That’s why this is typically a good strategy. So let’s say, out of 12 months maybe 9 or 10 of them work out in your favor and the other doesn’t.

Well what happens then?

Well you take the money and then you just buy more stock and you keep doing this process over and over again. You could continue doing this strategy if you like. It just really comes down to doing the setup.

So let me show you how this setup really works on the platform (ThinkOrSwim).

Let’s do Disney here.

Let’s say I have 100 shares of stock.

This is our position.

I could have be down on the position I could be up on the position. Now I want to go ahead and sell some premium against it. Let’s say the stock is standing around, it’s not doing much.

I still believe in the stock but I just don’t know if it’s gonna continue heading higher.

What I want to do is while I wait, make some premium.

How do I do that?

I could go 30 days out 29 days 36 days 42 days 57 days. The further the duration you go, the wider you can get for the same amount of money in a way. So if you look at 29 days, let’s say you go to the 140 you only make 33 cents.

But your time decay is fast, 40 cents or so.

At 57 days, the 140, you make 94 cents. So if I wanted to make 33 cents, I could go out to the 155. You could make a lot more money.

The downside is you got away longer, right? So here I can go ahead and sell this single call contract.

What does that do? If that stock goes up, I still make money. But once it hits 150, that stock gets called away from me.

So at 150, I still make 3,195 dollars. And you can see that right here three thousand and one hundred and ninety five dollars. So that’s what I would make there at expiration but if it continues to head higher.

I still only make, if the stock price is at 160 dollars, 3,195 dollars. But without that call contract at 160, I would make $4,150 or so.

So you’d make a lot more if that price kept heading higher. But again, does the stock really head that high to the moon all the time?

No it does not.

So that’s why this strategy is a fairly good strategy that a lot of beginners start with. I could go ahead and move it even tighter. We’re here and at the 150, I make .37 cents.

What if I move this to the 130? Now I make 2.19 dollars.

What’s the problem here? Now I get called away when the stock is here

rather than over here.

So I’ve got a lot less room in my trade for me to keep the stock but I make premium.

In this case what happens is stock stands still, I still make my 214 dollars.

If it goes down, I lose value on the stock.

In this case, it would be down 1,633 dollars. But that includes my premium.

What if I didn’t have my premium? I’d be down 1,842 dollars.

So you could see that premium actually does help you and protect you a little bit but not a lot.

If the stock does head higher and higher, could you get out of it and keep your stock? Yeah you could. Or if it continues to head higher, you could get that stock called away but you still make your premium.

In our case here, the premium is 2.19 which is 219 dollars.

So if it goes past that point, $219 it’s still yours but I have to deliver the stock and that’s kind of the downside.

Final Thoughts

For most people the stocks aren’t going to explode.

Sometimes they’ll move pretty close and then pull back and in that case, you still can keep your stock as long as it kind of doesn’t hang out there at expiration and go in the money.

Then you should still be okay but just be prepared if you’re doing this strategy. Your stock might be gone if it goes past the point at what you sell it.

The good news is, you get to make some premium on it. Then what you can do is buy those shares again and continue the process. Some people do this with 500 shares then you could do this with only 4 contracts.

That way you keep still some stock, right? So that’s why that profit picture would still keep going.

You don’t have to do this with all 5 shares because 5 contract would then balance you completely flat.

If you just did sold 3 contracts, at this point you’d get 300 shares gone and then the other few hundred would continue. You’d still have the stock ownership.


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