The Covered Call: An Income-Generating Options Strategy

by Michael C. Thomsett

The covered call provides extra income to a buy-and-hold strategy. In exchange for this income, there is a risk of lost opportunity. If the stock’s price rises well above the fixed strike price of the call, you have your 100 shares of stock called away below current market value. For some investors, this is an unacceptable risk; for others, it is gladly accepted given the potential extra returns from writing covered calls.

A Few Options Basics

The popularity of options trading has grown in recent years. Many investors and traders have realized that options can be used not only to speculate, but also as a means for managing a long-term stock portfolio, taking profits without needing to sell stock, and reducing the threat of losses. Among the dozens of possible strategies, covered call writing is especially popular for its potential to generate extra income for a portfolio.

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Michael C. Thomsett is author of over 70 books, including “Bloomberg Visual Guide to Candlestick Charting” (John Wiley & Sons, 2012) and “Getting Started in Options,” 8th edition (John Wiley & Sons, 2010). He lives in Nashville, Tennessee, and writes full time (www.michaelthomsett.com).


Discussion

Mike from California posted over 3 years ago:

Using covered calls to generate monthly income from a portfolio of stocks/ETFs is a good idea in all but a strong bull market. There is a free tutorial (with examples) and a covered call screener here:
http://www.borntosell.com


Richard from California posted over 3 years ago:

I like this strategy in a stock pickers market which I believe we are in. so rather than depending upon the use of ETF to diversify my portfolio and to capture an asset allocated return for safety and marginal return I will pursue a covered call return on a limited number of well investigated "safe stocks"


Kevin from Virginia posted over 3 years ago:

I like the strategy also and try to find stocks that pay larger than average dividends because you can still collect those dividends therefore adding to your returns.


Samuel from Florida posted over 2 years ago:

My interest is in covered calls .You cover this area extremely well. I am interested in leaps.Can you fully explain the theory governing this method . Advise .


Chris from Iowa posted over 2 years ago:

Writing the call with a buy/write strategy can reduce your initial purchase cost. You can even write an in-the-money (ITM) call if all the possible results are acceptable to you. Writing a (deeper) ITM call is also a way to get a bonus when you want to sell a stock if you are willing to accept the risk of holding on to the stock for a while.


Marc Abear from New Hampshire posted about 1 year ago:

Another aspect of covered calls that can work for you is recovery by call. Say you picked a stock because you liked the hypothesis, the financials look good. It becomes a long term buy and hold for you. With that said things go badly despite proper due diligence and the stock price drops below your entry point. Maybe you bought the peak, maybe the market reverses, maybe the industry leader misses earnings and the sector takes a hit. Whatever the reason the stock price dips, maybe not enough to get stopped out but below your entry point.

As long as the stock did not get away from you completely, the recovery by call strategy is to write covered calls repeatedly, usually for low premium levels. The premium collected each time is tracked and when you have recovered the difference between the entry point and the current stock price you can change the break even point of the position giving you a different and earlier decision point for exiting the position without a loss. Certainly if you continue to hold your belief in the security one could stay in the position... but occasionally we change our minds and want to try a different different opportunity.

For all of the billiards players out there, think of it as using a little English to improve your leave.


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