How to Sell Covered Calls on Stocks

by Mike Parker, Demand Media
    Listed options trade on exchanges in much the same fashion as stocks.

    Listed options trade on exchanges in much the same fashion as stocks.

    There are two primary ways to make money from your stock investments. If the company is profitable, the board of directors might vote to pay a dividend to shareholders. If the market finds the company attractive, the price of its stock might increase, giving you the opportunity for a capital gain. But sometimes your stock might not pay a dividend, and the stock price might not move all that much. You can still create some income by selling covered call options against your stock.

    Step 1

    Open an options account with an investments brokerage firm. Even if you already have a broker, you'll have to fill out a new account application form for an options account. Not all investors qualify for all types of investment transactions. Options trading isn't appropriate for all investors, and since some options trading strategies involve considerable risk, your brokerage firm must approve your account before you'll be allowed to place an order. The firm should give you a copy of the brochure, "Characteristics and Risks of Standardized Options" -- sometimes referred to as the options disclosure document -- which discusses the pros and cons of investing in options. Read it thoroughly and make sure you understand what's involved with selling covered call options before you open your options account.

    Step 2

    Determine the parameters you want to put on your transaction. When you sell a covered call option, you're agreeing to sell your stock on demand for a set price (the strike price) for a set period of time (defined by an expiration date) in exchange for a set payment (the premium). American options are typically issued in three-month cycles for up to one year, so you can choose how long you're willing to commit to. Options on your stock might have a number of different strike prices. The strike price and time remaining before expiration will determine the premium you receive for selling the option. You must maintain ownership of the underlying stock for as long as the option is active. If you sell your stock while the option is still active, your call option becomes uncovered and you incur unlimited risk.

    Step 3

    Place a sell order with your broker, specifying the underlying stock, the number of options you want to sell, the strike price and the expiration date. Each option controls 100 shares of the underlying stock. The same types of sell orders that are available for stock transactions are available for options orders. For example, you can sell at-the-market or you can place a sell-limit order, which will only execute if the market price for the option is at or above the price you specify.

    Step 4

    Watch the market. As long as the market price of the stock remains below the strike price of your covered call option it is highly unlikely that anyone will exercise the option, since they could buy the stock for less money on the open market. In that case the option will expire unexercised and you'll get to keep your stock and the premium you received for selling the call option. If the stock price begins to rise and you don't want to risk having to sell your stock, you can close out your position by purchasing an identical call option. Your short position from selling the covered call option and your long position from buying the call option will cancel each other out. The amount you pay to close your position might be more or less than the premium you receive when you sell the option.

    About the Author

    Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.

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