One way of earning additional income from your investment portfolio is by using the covered call strategy. This strategy is a good way to generate low but steady income from your investments.
For example, let’s say you pay $48.80 per share for your stock and think that it will rise to $60 within one year. Also, you’d be willing to sell at $55 within six months, knowing you were giving up further upside, but making a nice short-term profit. In this scenario, selling a covered call on your stock position might be an good choice for you.
You would then be able to sell 1 call for every 100 shares of stock you own, since each call is for 100 shares.
|ABC trading @ $48.80|
|Buy 100 ABC @ $48.80||$4,880.00|
|Sell 1 55 Call @ $1.80||($180.00)|
|Cost of Trade||$4,700.00|
Since you know that the price of the stock is not fluctuating, you now believe that it is not getting to be higher than $55 in short term. At expiration, if ABC stock is still below $55, you can then keep your $180 by letting the calls you shorted expire worthless and keep the shares of ABC stock that you own. You might also decide to sell another call after this. Over time, this lowers the cost basis of your shares! You can repeat the process to the point where you have owned your shares for FREE! (who doesn’t love free?)
Should the price of the stock go over $55, you can then buy back the calls or let your shares get called away where you would be selling them to the call owner you sold calls to for 55.00 per share . This give you $620 in profit from your 100 shares and $180 profit from the shorted call for a total of $800.
What you have to remember is that most investors when selling covered calls, sell near month options. This is because the earlier the expiration, the less likely the stock will trade through the specified strike price. Another reason is because of time decay. The call has no intrinsic value and the only value is the time value.
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