Free stock trading education: The basics of covered calls

TradingPub Admin | May 28, 2013

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If you are interested in some free stock trading education that can potentially provide you with myriad benefits, covered call writing is a good strategy for you to learn more about.

In harnessing this strategy, you would buy some shares of stock and then write or sell a call option for those assets, Eric Aafedt, president and founder of CoveredCall.Com, writes in an article on his website. In buying this option contract, the owner would obtain the right, but not the obligation, to purchase those shares at a certain strike price within a certain time frame.

For example, if Target Corporation stock is currently valued at $100, you could buy 100 shares and sell a call option for these equities with a strike price of $100 and a expiration of time frame of eight months. As a result, the entity that buys the call can buy the stock for this predetermined price during the eight-month period.

Growing visibility of covered calls
This strategy was formerly used primarily by institutional investors and other sophisticated market participants, but it has become more common, wealth coach Tyrone Jackson writes in a Huffington Post blog piece. He notes that these tactics are not considered to be too intricate by those who work on Wall Street, and they can be used by you.

He said that many individuals can harness this technique, which was formerly utilized by hedge fund managers and other advanced investors, by harnessing the online trading software that is offered by many brokerage firms.

Income a major draw of strategy
The author states that one factor that might motivate you to harness such a strategy is boosting the income that is generated by your portfolio, as many traders write covered calls for just this reason. By selling these options on a regular basis, you can receive some premiums.

Aafedt writes that many people who depend in dividend payments can benefit from harnessing covered calls. He notes that individuals who use this strategy of collecting these regular payments most likely expect that their stocks will obtain modest appreciation over time. For example, if a person owns 100 shares of a blue-chip stock that are valued at $65 each and have a dividend yield of roughly 2 percent, they will receive a little more than $3 in these payments per year for each share.

This individual could potentially sell a call option that provided the buyer with ownership rights to these 100 shares, according to Aafedt. If one of these contracts with a five-month expiry was trading at $3.40 per share higher than the existing stock price, then a 12 percent return could be created by selling two of these call options a year and then adding that to the aforementioned dividend payments.

Key considerations
It is important to keep in mind that if you decide to buy 100 shares for $100 and then write a call option on these assets for this exact same price, and then these equities appreciate to $110 apiece, you will lose out on the returns that would have been generated.

Being able to distinguish between the stocks you should hold long-term and those that you should retain for selling covered calls is a crucial step in getting the best possible results from writing covered calls, Jackson notes. He emphasizes that in this day and age, you have all the information, tools and software you need right at your fingertips so you can use this strategy. However, one crucial component needed to harness this strategy is knowing what to do. 

If you want quality stock trading education, it is available through TradingPub, home to some of the top investors and traders in the industry.