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Covered Calls |
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Covered calls are a means to earn additional income on a stock portfolio. It is an excellent way to generate income for conservative investors.
For example: An investor purchases 100 shares of Time Warner stock with the stock at $24.40 and wants like to hold the stock rather than sell it. Instead of simply collecting the dividends on the Time Warner stock, the investor uses options to generate additional income at minimal risk to himself.
With the stock at $24.40 the investor sells one 27.5 call in the near month at $0.90. As each call is valid for 100 shares the investor is only able to sell one call. Since the stock price hasn’t changed much, the investor has confidence that it isn't going to move higher than $27.50 in the short term, as that would be more than a 10% move. At expiration, if the stock is still below $27.50, the investor keeps the $90 received by selling the calls and the 100 shares of stock. At that point, the investor might decide to write another call for a future month.
Should the stock rise unexpectedly above $27.50, the investor can either buy the calls back and keep the stock or let the stock be called away and sell the 100 shares (1 contract x 100 shares) at the strike price of $27.50. The benefit is that the investor participated in the rise from $24.40 to $27.50 on the 100 shares he sold at 27.5, locking in an additional $310 in profit. The disadvantage is that the investor may have capital gains tax to deal with, especially if the stock has been owned for a long time and the cost basis was low.
When writing covered calls, most investors tend to sell near month options because the earlier the expiration, the less opportunity the stock has to trade through the strike price, as well as the role time decay plays in the value of the options. Like all out-of-the-money options, the call has no intrinsic value. The only value is the time premium or time value which, in the final month before expiration, decays more and more rapidly. Therefore investors often sell options that have one month remaining until expiration.
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| Symbol |
Rate |
| GBP:CHF |
1.747703 |
| GBP:JPY |
155.484239 |
| GBP:USD |
1.638403 |
| NZD:USD |
0.627050 |
| EUR:CAD |
1.545998 |
| EUR:CHF |
1.516857 |
| EUR:GBP |
0.867915 |
| EUR:JPY |
134.947096 |
| EUR:USD |
1.421994 |
| AUD:JPY |
76.394373 |
| AUD:USD |
0.805000 |
| USD:CAD |
1.087204 |
| USD:CHF |
1.066711 |
| USD:JPY |
94.899879 |
| USD:SEK |
7.613010 |
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Disclimer: This website is for informational purposes only and is not intended to provide
specific commercial, financial, investment, accounting, tax, or legal advice.
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© ForexCenter.com, 2005, All Rights Reserved
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