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Covered call writing is an income-generating strategy you can use to increase the return on your stock holdings. It is also a strategy to use to cushion your losses if you think the market will experience a slight pullback in the near future. Some investors use them alongside dividend payouts to generate income during retirement, although you may suffer losses during a market downturn. If you’re willing to take the risk involved, covered call options might be worth looking into.
Knowing the strategy is only part of the execution. To maximize the use of covered call options, you should select stocks that you believe will not experience highly volatile moves during the term of your options contract. Let’s review some good candidates that you may be able to use in a flat or rising market.
Overview: Call Options and Covered Stocks
Selling a covered call means selling a call option against shares you own. This combination has the same risk profile as selling a naked put option, and therefore exposes you to virtually unlimited downside risk while having only limited upside potential to the strike price. If you sell a call option, it loses value if the stock price goes down or if the market remains relatively stable over time.
With the covered call strategy, if the stock price increases, the gain in value of your stock fully covers the losses of your call option above the strike price of the option. At expiration, you will show a net gain if the stock price has reached or exceeded the strike price of your sold option, although you must either give up your stock or close the option if the option closes. ends in the- the money at expiration. Also, if the value of your stock drops by more than the premium for which you sold the call option, you could lose money as if you had sold a naked put option.
Writing covered call options can also lower your stock purchase costs. If you own $13,000 of Walmart divided into 100 shares, your cost base is $130. If you sell a covered call on 100 shares against those shares for $115, your cost basis decreases by $1.15 per share. It’s like buying the stock at $128.85 instead of $130, although your profit potential is eliminated if the market rises above the strike price at expiration.
While this combined position has unlimited downside risk, it could present an attractive proposition if you’re tailoring your portfolios for income rather than growth. It’s also a good consideration if you expect a relatively flat to slightly rising market for a stock over a period of time.
Best Online Brokers for Covered Calls
The best stock market candidates for covered call writing are usually large, blue chip stable companies listed on major stock exchanges. These choices are usually available from reputable brokers who offer stock options to their clients. Take a look at these market leaders and compare their feature sets to make sure they best suit your needs and preferences.
Features To Look For In Covered Call Actions
- Sideways market activity: Options are contracts that can lose their time value as they approach expiration, although their time value also depends on other factors such as volatility levels and proximity to the strike price of the option. option in relation to the current market. If you write a covered call option against stocks you own, you will generally make a profit over time since the stock price is stable.
- Uneventful stock: The less a security is featured in news events, the less likely it is to be affected by the resulting drastic price changes as market participants engage in emotional buying and selling.
- A clear and unremarkable schedule: You can’t avoid unexpected shocks to a stock or market, but you can anticipate and choose stocks with issuing companies that don’t anticipate anything that could potentially create volatile trading conditions. Risky events you would probably want to avoid include product trials, mergers and acquisitions, earnings announcements, and management changes.
Dividend investors who do not plan to write covered calls may miss additional income in relatively stable and predictable markets. There is a risk of holding stocks in your portfolio, and you can adjust this risk by selling covered calls. Writing covered call options is a strategic way to earn income to cap your profits while cushioning the risk of virtually unlimited losses should your stock price decline.
In general, stocks under $10 and stocks under $5 are generally not good candidates for the covered call strategy. Stick to large-cap blue chips instead because of their greater liquidity which tends to result in more orderly markets. If you need more help with market strategies, consider checking out the Benzinga options newsletter. Bookmark this site for more up-to-date information on covered calls and other strategies that can help you get the most out of the market.